Stock Market’s Movements and Reactions

Investors reaction

Listen to this postMarket efficiency remains inconclusive for many reasons, but one of them is stock price overreaction to information (Ball, 2001). The “Recency Theory” state that traders overestimate recent information and become too optimistic when the firm is winning and too pessimistic when the firm is losing, therefore the traders tend to overreact to recent information (Offerman & Sonnemans, 2004). The “Hot-Hand theory” states that the past winning or losing record of a firm will convince the traders to overvalue or undervalue the firm thus overreact to the information (Offerman & Sonnemans, 2004). A study by Ma, Tang, & Hasan (2005) selected 852 stocks (between 1996 to 1997) and found strong evidence of price reversal after two days of stock price overreaction. The study suggest constructing a strategy to predict the price reversal to gain profit from the overreacted price margin. The above theories and study would be a good research topics for exploration.

Econometric is defined by Encyclopedia Britannica as “the statistical and mathematical analysis of economic relationships” (“Econometrics,” 2009) such analysis use statistical techniques like linear regression to find the relationship between two economical variables. The econometric techniques are useful in finding the elasticity between commodity price and customer’s demand.  Another use of the techniques would be for production cost. In production cost the technique test the relation between the firm’s output and production factors like cost of labor, rent, capital and machinery.

Daniel Gross author of the book “Dumb Money: How Our Greatest Financial Minds Bankrupted the Nation” stated that economists and business leaders are realizing that economic models (like econometric) are helpful to predict the future when enough past data is available; but they fail to predict when major turnaround in the past performances occur. Daniel calls the phenomena as “pro forma disease” when economist depend too heavy on the data to predict the future. Daniel gives an example when a market is growing 10% for the past 4 year, the economist would predict another 4 years of 10% growth. Daniel claims that many economical models use resent years data without incorporating enough past data to that shows major turnarounds in the economy.

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References:

Ball, R. (2001). The theory of stock market efficiency: accomplishments and limitations. In The new corporate finance: where theory meets practice (3rd ed., pp. 20-33). New York: McGraw-Hill Irwin.

econometrics. (2009). In Encyclopædia Britannica. Retrieved February 28, 2009, from Encyclopædia Britannica Online:  http://www.britannica.com/EBchecked/topic/178298/econometrics

Gross, D. (2009, February 27). Slate on washigtonpost.com. The Washington Post. Retrieved February 28, 2009, from The Washington post Web site: http:/​/​www.washingtonpost.com/​wp-dyn/​content/​discussion/​2009/​02/​26/​DI2009022602876.html

Ma, Y., Tang, A., & Hasan, T. (2005, Summer/Autumn2005). The stock price overreaction effect: evidence on NASDAQ stocks. Quarterly Journal of Business & Economics44(3/4), 113-127.

Offerman, T., & Sonnemans, J. (2004). An experimental investigation of recency and the hot-hand effect. Scandinavian Journal of Economics, 106(3), 533-554.

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About Sami Malallah
My thoughts and ideas are without politics, sarcasm or negativity. Please comment on them and share them with others.

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