Price Shocks and Investor Irrationality

Abstract: This paper replicates the research conducted by Benou and Richie (2003) on overreactions among investors to news or events causing large price changes to occur in the stock market. While the original study focuses solely on large price decreases among well-established firms listed in the S&P 100 index on the U.S. stock market, this study analyzes the Swedish stock market. Furthermore, this paper extends the research to include both large and small firms, defined by market value, listed on Nasdaq Stockholm stock exchange. The two groups are studied separately, and we observe events defined both as positive and negative price shocks. This is done to study whether the stock market adjusts immediately according to the new circumstances due to the event, or if the investors invariably overreact or underreact to corporate news affecting the stock price. The latter alternative would result in mispriced stocks the following months after the large price movement. In contrast to the findings of Benou and Richie, where evidence for a systematic overreaction to large price declines is presented, our results show a tendency among investors to underreact to large price decreases while overreacting to large price increases. Therefore, we conclude that investors in the Swedish stock market show tendencies to be overly optimistic. This is only seen among large firms in the Swedish stock markets. Moreover, no inferences can be stated regarding stock price trends following a large price shock among companies with a lower market value, since all our results for smaller firms are statistically insignificant.