Short-Term Price Overreaction: Identification, Testing, Exploitation

29 Pages Posted: 19 Nov 2014

See all articles by Guglielmo Maria Caporale

Guglielmo Maria Caporale

Brunel University - Centre for Empirical Finance

Luis A. Gil-Alana

University of Navarra - Department of Economics

Oleksiy Plastun

Sumy State University

Date Written: October 2014

Abstract

This paper examines short-term price reactions after one-day abnormal price changes and whether they create exploitable profit opportunities in various financial markets. A t-test confirms the presence of overreactions and also suggests that there is an "inertia anomaly", i.e. after an overreaction day prices tend to move in the same direction for some time. A trading robot approach is then used to test two trading strategies aimed at exploiting the detected anomalies to make abnormal profits. The results suggest that a strategy based on counter-movements after overreactions does not generate profits in the FOREX and the commodity markets, but it is profitable in the case of the US stock market. By contrast, a strategy exploiting the "inertia anomaly" produces profits in the case of the FOREX and the commodity markets, but not in the case of the US stock market.

Keywords: Efficient Market Hypothesis, anomaly, overreaction hypothesis, abnormal returns, contrarian strategy, trading strategy, trading robot, t-test

JEL Classification: G12, G17, C63

Suggested Citation

Caporale, Guglielmo Maria and Gil-Alana, Luis A. and Plastun, Oleksiy, Short-Term Price Overreaction: Identification, Testing, Exploitation (October 2014). DIW Berlin Discussion Paper No. 1423. Available at SSRN: https://ssrn.com/abstract=2526817 or http://dx.doi.org/10.2139/ssrn.2526817

Guglielmo Maria Caporale (Contact Author)

Brunel University - Centre for Empirical Finance ( email )

Uxbridge UB8 3PH
United Kingdom

Luis A. Gil-Alana

University of Navarra - Department of Economics ( email )

Campus de Arrosadia
Pamplona, 31006
Spain

Oleksiy Plastun

Sumy State University ( email )

Rymskyi-Korsakov str., 2
Sumy, 40000
Ukraine

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