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Short-Term Price Overreactions: Identification, Testing, Exploitation

Author

Listed:
  • Guglielmo Maria Caporale
  • Luis A. Gil-Alana
  • Alex Plastun

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.

Suggested Citation

  • Guglielmo Maria Caporale & Luis A. Gil-Alana & Alex Plastun, 2014. "Short-Term Price Overreactions: Identification, Testing, Exploitation," CESifo Working Paper Series 5066, CESifo Group Munich.
  • Handle: RePEc:ces:ceswps:_5066
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    File URL: https://www.cesifo-group.de/DocDL/cesifo1_wp5066.pdf
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Razvan Stefanescu & Ramona Dumitriu, 2016. "Contrarian and Momentum Profits during Periods of High Trading Volume preceded by Stock Prices Shocks," Risk in Contemporary Economy, "Dunarea de Jos" University of Galati, Faculty of Economics and Business Administration, pages 378-384.
    2. Guglielmo Maria Caporale & Luis Gil-Alana & Alex Plastun, 2015. "Long-Term Price Overreactions: Are Markets Inefficient?," Discussion Papers of DIW Berlin 1444, DIW Berlin, German Institute for Economic Research.
    3. Guglielmo Maria Caporale & Alex Plastun, 2018. "Price Overreactions in the Cryptocurrency Market," Discussion Papers of DIW Berlin 1718, DIW Berlin, German Institute for Economic Research.

    More about this item

    Keywords

    efficient market hypothesis; anomaly; overreaction hypothesis; abnormal returns; contrarian strategy; trading strategy; trading robot; t-test;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques

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