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Market Overreaction Explained

In: Following the Crowd: Psychological Drivers of Herding and Market Overreaction

Author

Listed:
  • Kok Loang Ooi

    (Universiti Malaysia)

  • Norazlin Binti Ab Aziz

    (Universiti Malaysia)

  • Wee Yeap Lau

    (Universiti Malaysia)

Abstract

Market overreaction refers to an investor’s disproportionate response to new information, often resulting in substantial price volatility that diverges from an asset’s intrinsic value. This phenomenon is influenced by cognitive biases, including availability heuristics, anchoring, and loss aversion, which skew investor perceptions and decision-making processes. Availability heuristics encourage investors to disproportionately focus on recent or salient events, anchoring their results in excessive reliance on initial price points, and loss aversion heightens their sensitivity to losses compared to profits. Consequently, market overreaction exacerbates volatility, creating opportunities for speculation and increasing financial instability. Comprehending this behaviour is essential for policymakers, financial analysts, and investors seeking to alleviate market inefficiency. An exemplary historical instance is the 1929 Stock Market Crash, where panic-induced overreaction led to a significant market collapse, underscoring the extensive economic ramifications of irrational investor behaviour. This chapter analyses market overreaction using theoretical frameworks and empirical data to elucidate its significance in financial markets.

Suggested Citation

  • Kok Loang Ooi & Norazlin Binti Ab Aziz & Wee Yeap Lau, 2025. "Market Overreaction Explained," Springer Books, in: Following the Crowd: Psychological Drivers of Herding and Market Overreaction, chapter 0, pages 23-42, Springer.
    • Handle: RePEc:spr:sprchp:978-981-95-0792-4_2
    DOI: 10.1007/978-981-95-0792-4_2
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