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How do Markets React to Fundamental Shocks? An Experimental Analysis on Underreaction and Momentum

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Author Info

  • Weber, Martin

    ()
    (Lehrstuhl für ABWL, Finanzwirtschaft, insb. Bankbetriebslehre)

  • Welfens, Frank

    ()
    (Lehrstuhl für ABWL, Finanzwirtschaft, insb. Bankbetriebslehre)

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    Abstract

    We perform a market experiment to investigate how average transaction prices react to the arrival of new information. Following a positive shock in fundamental value, prices underreact strongly; following negative shocks we find evidence of a much less pronounced underreaction. After the shock, prices in both situations slowly drift towards the new fundamental value, leading to a characteristic momentum pattern. Controlling for investors’ individual disposition effects we form high and low disposition markets and prove both underreaction and momentum to be stronger in the high disposition group. While evidence is mainly in favor of Grinblatt and Han (2005), we conclude based on our underreaction finding that positive and negative shocks are not two sides of the same coin and encourage future studies to disentangle the asymmetry between the two situations more carefully.

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    File URL: http://www.sfb504.uni-mannheim.de/publications/dp07-42.pdf
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    Bibliographic Info

    Paper provided by Sonderforschungsbereich 504, Universität Mannheim & Sonderforschungsbereich 504, University of Mannheim in its series Sonderforschungsbereich 504 Publications with number 07-42.

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    Length: 0 pages
    Date of creation: 27 Jun 2007
    Date of revision:
    Handle: RePEc:xrs:sfbmaa:07-42

    Note: Financial support from the Deutsche Forschungsgemeinschaft, SFB 504, at the University of Mannheim, is gratefully acknowledged.
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    References

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    1. Andrea Frazzini, 2006. "The Disposition Effect and Underreaction to News," Journal of Finance, American Finance Association, vol. 61(4), pages 2017-2046, 08.
    2. Uri Gneezy & Arie Kapteyn & Jan Potters, 2003. "Evaluation Periods and Asset Prices in a Market Experiment," Journal of Finance, American Finance Association, vol. 58(2), pages 821-838, 04.
    3. Goetzmann, William & Massa, Massimo, 2004. "Disposition Matters: Volume, Volatility and Price Impact of Behavioural Bias," CEPR Discussion Papers 4814, C.E.P.R. Discussion Papers.
    4. Plott, Charles R. & Sunder, Shyam., . "Rational Expectations and the Aggregation of Diverse Information in Laboratory Security Markets," Working Papers 463, California Institute of Technology, Division of the Humanities and Social Sciences.
    5. Michael S. Haigh & John A. List, 2005. "Do Professional Traders Exhibit Myopic Loss Aversion? An Experimental Analysis," Journal of Finance, American Finance Association, vol. 60(1), pages 523-534, 02.
    6. Urs Fischbacher, 2007. "z-Tree: Zurich toolbox for ready-made economic experiments," Experimental Economics, Springer, vol. 10(2), pages 171-178, June.
    7. William N. Goetzmann & Massimo Massa, 2004. "Disposition Matters: Volume, Volatility and Price Impact of a Behavioral Bias," Yale School of Management Working Papers ysm331, Yale School of Management.
    8. Camerer, Colin & Loewenstein, George & Weber, Martin, 1989. "The Curse of Knowledge in Economic Settings: An Experimental Analysis," Journal of Political Economy, University of Chicago Press, vol. 97(5), pages 1232-54, October.
    9. Plott, Charles R & Sunder, Shyam, 1982. "Efficiency of Experimental Security Markets with Insider Information: An Application of Rational-Expectations Models," Journal of Political Economy, University of Chicago Press, vol. 90(4), pages 663-98, August.
    10. Genesove, David & Mayer, Christopher, 2001. "Loss Aversion and Seller Behaviour: Evidence from the Housing Market," CEPR Discussion Papers 2813, C.E.P.R. Discussion Papers.
    11. Thaler, Richard, 1980. "Toward a positive theory of consumer choice," Journal of Economic Behavior & Organization, Elsevier, vol. 1(1), pages 39-60, March.
    12. Weber, Martin & Camerer, Colin F., 1998. "The disposition effect in securities trading: an experimental analysis," Journal of Economic Behavior & Organization, Elsevier, vol. 33(2), pages 167-184, January.
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    Cited by:
    1. K.S. Muehlfeld & G.U. Weitzel & A. van Witteloostuijn, 2012. "Fight or freeze? Individual differences in investors’ motivational systems and trading in experimental asset markets," Working Papers 12-18, Utrecht School of Economics.

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