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Long-Term Price Overreactions: Are Markets Inefficient?

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  • Guglielmo Maria Caporale
  • Luis Gil-Alana
  • Alex Plastun

Abstract

This paper examines long-term price overreactions in various financial markets (commodities, US stock market and FOREX). First, t-tests are carried out for overreactions as a statistical phenomenon. Second, a trading robot approach is applied to test the profitability of two alternative strategies, one based on the classical overreaction anomaly, the other on a so-called “inertia anomaly”. Both weekly and monthly data are used. Evidence of anomalies is found predominantly in the case of weekly data. In the majority of cases strategies based on overreaction anomalies are not profitable, and therefore the latter cannot be seen as inconsistent with the EMH.

Suggested Citation

  • 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.
  • Handle: RePEc:diw:diwwpp:dp1444
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    File URL: http://www.diw.de/documents/publikationen/73/diw_01.c.495370.de/dp1444.pdf
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    References listed on IDEAS

    as
    1. Allen M. Poteshman, 2001. "Underreaction, Overreaction, and Increasing Misreaction to Information in the Options Market," Journal of Finance, American Finance Association, vol. 56(3), pages 851-876, June.
    2. Brown, Keith C. & Harlow, W. V. & Tinic, Seha M., 1988. "Risk aversion, uncertain information, and market efficiency," Journal of Financial Economics, Elsevier, vol. 22(2), pages 355-385, December.
    3. De Bondt, Werner F M & Thaler, Richard, 1985. " Does the Stock Market Overreact?," Journal of Finance, American Finance Association, vol. 40(3), pages 793-805, July.
    4. Bruce N. Lehmann, 1990. "Fads, Martingales, and Market Efficiency," The Quarterly Journal of Economics, Oxford University Press, vol. 105(1), pages 1-28.
    5. Guglielmo Maria Caporale & Luis Gil-Alana & Alex Plastun, 2018. "Short-Term Price Overreactions: Identification, Testing, Exploitation," Computational Economics, Springer;Society for Computational Economics, vol. 51(4), pages 913-940, April.
    6. Adam Clements & Michael E. Drew & Evan M. Reedman, 2007. "The Death of the Overreaction Anomaly? A Multifactor Explanation of Contrarian Returns," School of Economics and Finance Discussion Papers and Working Papers Series 219, School of Economics and Finance, Queensland University of Technology.
    7. Mynhardt, H. R. & Plastun, Alex, 2013. "The Overreaction Hypothesis: The Case of Ukrainian Stock Market," MPRA Paper 58941, University Library of Munich, Germany.
    8. Antonios Antoniou & Emilios C. Galariotis & Spyros I. Spyrou, 2005. "Contrarian Profits and the Overreaction Hypothesis: the Case of the Athens Stock Exchange," European Financial Management, European Financial Management Association, vol. 11(1), pages 71-98, January.
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    12. Alonso, Aurora & Rubio, Gonzalo, 1990. "Overreaction in the Spanish equity market," Journal of Banking & Finance, Elsevier, vol. 14(2-3), pages 469-481, August.
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    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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