Abstract
Stock market overreacts to both anticipated and unanticipated stock-specific news. But even in the absence of any firm-specific news, evidences of extreme price changes have been observed in the stock market. This particular phenomenon creates the need of further study to examine the existence of overreaction even if there is no specific public news in the market.
The present study tries to find out how stocks overreact in the case of unspecified events in comparison to specified news in the Indian stock market. Specified events can be monitored up to a certain extent because of their known and repetitive nature. The magnitude of uniqueness of the unspecified events increases uncertainty. Information diffusion is more asymmetric, which leads to more stock market overreaction. The study also examines whether there is a relationship between the magnitude of price reversals and the magnitude of gain or loss in the stock market return.
Significant cumulative abnormal returns are found, indicating the existence of an overreaction effect. It is also found that the magnitude of price reversal is inversely proportional to the stock return during the event period. The overreaction effect continues up to about two days after the event date, for the present sample.
Thus, the study provides an understanding of overreaction effects, which would enable investors to prepare trading strategies for higher returns. It can be said that the Indian stocks show strong overreaction and reversal effect. It shows that a trading strategy can be used to make contrarian profit from the overreaction and reversal exhibited by the Indian stocks. An investor could buy the largest percentage losers stocks or sell largest percentage gainers stocks, then sell the former one and buy the latter one after two trading days. In this way, the optimum utilization of overreaction effects may increase investors' return. Overreaction is more prominent in the case of unspecified events rather than specified events. Stock prices overreact to private news but underreact to subsequent public announcements. Overreaction increases due to information asymmetry and leakage. In the case of any macro/global issues, overreaction is also more because of market integration and globalization.