Investor Overreaction: Evidence From Bull and Bear Markets

Abstract

In this paper, we provide new evidence to strengthen the investor overreaction hypothesis by examining a new context that has not been explored before. Our research is inspired by the widely held belief that investor sentiment experiences abrupt changes from optimism to pessimism as the market switches between bull and bear states. If the investor overreaction hypothesis is correct, it implies that investors are inclined to become excessively optimistic during bull markets and overly pessimistic during bear markets, resulting in overreaction and subsequent market correction. The study's results support the hypothesis, showing evidence of market overreaction during bear markets and strong price increases at the beginning of bull markets. The study also finds that the price increase toward the end of a bull market is less prominent and that a significant price drop at the beginning of a bear market can be attributed to panic selling rather than a market correction. The study highlights the importance of investor sentiment in driving market movements and the potential for overreaction and subsequent correction.

Keywords: investor overreaction, market correction, bull and bear markets

JEL Classification: G10, G14, G40