Mispricing Following Public News: Overreaction for Losers, Underreaction for Winners
affiliation not provided to SSRN
Massachusetts Institute of Technology Department of Economics
Sorin M. Sorescu
Texas A&M University - Department of Finance
March 17, 2008
We document an important relation between two well-established anomalies: momentum and short-term reversal. Only stocks with negative momentum experience short-term reversal. Using Chan's (2003) news database, we show that the market appears to overreact to public news following bad past performance and underreact following strong past performance. The results are robust to using alternative methodologies. Stocks with current good news and negative momentum earn on average -9.3% annual raw returns during the subsequent month, while stocks with current good news and positive momentum earn 32.2%. The large, negative raw returns point to cognitive biases, rather than risk-based explanations, as the source of abnormal returns.
Number of Pages in PDF File: 44
Keywords: Momentum, reversion, cognitive biases, market efficiency, anomalies, overreaction, underreacton, overconfidence, cognitive dissonance
JEL Classification: G12, G14working papers series
Date posted: March 25, 2008
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