Stock Price Overreaction Effect: Evidence on Nasdaq Stocks, The

Quarterly Journal of Finance and Accounting, Summer 2005 by Ma, Yulong, Tang, Alex P, Hasan, Tanweer

Methodology

We obtain daily stock returns from the Daily CRSP Database. We estimate abnormal returns by using the market model suggested by Brown and Warner (1985). To mitigate the size difference between NYSE and Nasdaq stocks, we use the equally weighted market index from the daily CRSP file as our proxy for market return of NYSE gainers and losers in the model. We use the Nasdaq index as the proxy for market return of Nasdaq gainers and losers.

Results

Abnormal Stock Returns

We first study the overreaction effect by examining the level and the significance of abnormal returns before, and particularly after, the event day on which the stocks have the largest percentage gains and losses. Table 2 shows the empirical results of abnormal returns for NYSE stocks.

Panel A of Table 2 contains the daily abnormal returns for both the samples of gainers and losers over day -5 to day 5. Panel B contains the CARs for these two samples over the event period of-10 to 50 days. The table shows that NYSE gainers record an average abnormal return of 21.66 percent on the event day, and NYSE losers record an average abnormal return of-17.87 percent on the event day. Both of these two abnormal returns are highly significant. Given such highly significant and large abnormal returns, we would expect significant price reversals if the overreaction effect exists. The results, however, show that none of the post-event daily abnormal returns are statistically significant at a commonly accepted level.

Panel A also shows the proportion of firms in the sample that have positive abnormal returns on each day from day -5 to day 5. Except on the event day, this ratio should average about 50 percent. The data in the table do not exhibit any significant difference in the pattern of values of the ratio before and after the event day. These results indicate that the overreaction effect for NYSE stocks is not significant during the two-year period of our study.

Our findings differ from the previous study by Cox and Peterson (1994), who use different criteria in selecting sample firms over the period 1963 to 1991. The different findings could suggest that the market structure development over the years has helped improve the market efficiency.

In Panel B of Table 2, we provide the CARs for six post-event time periods, (-10, -2), (-1, O), ( 1, 2), ( 3, 10), ( 11, 20) and ( 21, 50). For the sample of both gainers and losers, there appear to be some price reactions prior to event day O. The CAR for the period of (-10, -2) is 1.37 percent, which is significant at the 0.05 level for the gainers. For the losers, the CAR for the same time period is -2.15 percent, which is significant at the 0.01 level. For the four post-event periods, none of the cumulative abnormal returns is significant for either the gainers or the losers.

Table 3 reports the empirical results of abnormal returns for the Nasdaq firms. Similar to Table 2, Panel A of the table shows the daily abnormal returns for both the samples of gainers and losers over day -5 to day 5. Panel B shows the CARs for these two samples over the event period of-10 to 50 days. In contrast to the results in Table 2, the data in Table 3 show significant price reversals after the event day, indicating that there exist significant overreaction effects for both Nasdaq gainers and losers. The event day abnormal returns are 38.01 percent and -35.32 percent for the samples of gainers and losers, respectively. For both samples, the daily abnormal returns are significant at the 1 percent level for the next two event days.