Markets overreact: The Contrarian Indicators

Or this one?

Markets overreact: The Contrarian Indicators

Basis: Research in experimental psychology suggests that people tend to overreact to unexpected and dramatic news events. In revising their beliefs, individuals tend to overweight recent information and underweight prior data.

Empirical evidence: If markets overreact then

(1) Extreme movements in stock prices will be followed by subsequent price movements in the opposite direction.

(2) The more extreme the price adjustment, the greater will be the subsequent adjustment

Evidence that Markets Overreact

Issues in Using Contrarian Indicators

(1) Why, if this is true, is is that contrarian investors are so few in number or market power that the overreaction to new information is allowed to continue for so long?

(2) In what sense does this phenomenon justify th accusation that the market is inefficient?

(3) Is the market more efficient about incorporating some types of information than others?

Prof. Aswath Damodaran