Overreaction hypothesis

Overreaction hypothesis

The supposition that investors overreact to unanticipated news, resulting in exaggerated movements in stock prices followed by corrections.

Overreaction Hypothesis

A theory stating that the crowd overreacts to both good news and bad news. For example, when a company announces unexpectedly high earnings, this can create a buying panic that unjustifiably drives up the company's stock price. Likewise, when the earnings are unexpectedly bad, there can be a selling panic that drives down the price. One can use the overreaction hypothesis to make short-term profits in either direction.
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It should be noted that both underreaction and overreaction hypothesis are not contradictory.
Investors overreact to star analyst forecasts and recommendations, particularly bull recommendations (Zhou et al., 2016); Ng and Wu (2007) and Wu (2011) also find that the pure contrarian strategy can, in the Chinese stock market, produce positive excess return, and a strategy combining mean reversion and momentum can outperform a buy-and-hold strategy, which collectively supports the overreaction hypothesis.
The overreaction hypothesis, as postulated by De Bondt and Thaler [9], dictates that stocks that have performed poorly in the past (low liquidate stocks) tend to outperform stocks that have performed well in the past (high liquidate stocks).
The authors postulated the overreaction hypothesis based on the findings of an experimental study in psychology conducted by Kahneman and Tversky [13], wherein individuals were found to initially overreact to the arrival of unexpected news.
TABLE 5 Summary Statistics of Variables Used for Overreaction Hypothesis Testing Variable Definition OVER Estimated overreaction 1.
Theories that support the relationship between pre-IPO operating performances, IPO's underpricing, and long run performances include the changing-risk composition hypothesis (Ritter, 1984) and the overreaction hypothesis (Daniel, Hirshleifer, & Subrahmanyam, 1998).
This finding supports the overreaction hypothesis and sets grounds for contrarian portfolio strategies.
The overreaction hypothesis and the UK stock market.
Further, if the market overreacts only to intangible information, it also seems reasonable to identify stocks as winners and losers based on intangible returns, rather than total returns (TR), to test the overreaction hypothesis of long-term return reversals.
The overreaction hypothesis is consistent with the notion that prices can move beyond equilibrium values, but will eventually reverse themselves as traders sort through the information.
The significance of the interaction between prior-year returns and forced selling pressure suggests that our results may also be consistent with the overreaction hypothesis. Under this hypothesis, investors and the firm's management disagree about publicly available information, prompting firm management to repurchase shares after they have experienced significantly negative returns.
The Overreaction Hypothesis (OH) explains these inefficiencies by predicting that prices will be undervalued preceding unfavorable announcements.