Short Term Predictability, Volume and Microstructure Effects in Stock Prices
59 Pages Posted: 11 Jul 2008
Date Written: July 10, 2008
This paper documents strong evidence for short term predictability of individual stocks in the London Stock Exchange. We find empirical evidence for price reversals after large price changes and price continuation after small price changes. Our results indicate that large companies seem to react more efficiently to previous price changes and that the effect has been robust over time. The results are robust to non-normality of returns and are not explained by market microstructure effects like nonsynchronous trading or bid-ask bounce. We further investigate whether the effect can be explained by rational asset-pricing theory or behavioral theories. In these investigations we employ volume as an additional explanatory variable. Finally when considering whether the predictability has any implications for market efficiency we show that the size of bid-ask spreads are highly related to previous price movements.
Keywords: Predictability, Overreaction, Underreaction, Market efficiency, Momentum, Volume, Microstructure
JEL Classification: G10
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