Article
Investor Reaction in Stock Market Crashes and Post-Crash Market Reversals
The International Journal of Business and Finance Research
(2015)
Abstract
De Bondt and Thaler (1985, 1987) argue that investors tend to overreact to economic
events. However, investor overreaction in stock market crashes has not been studied
sufficiently. In this paper, we study this issue with data for five major stock market
crashes during the 1987-2008 period. We find evidence of investor overreaction in all
five stock market crashes. The prices of stocks investors bid down more than the average
during crashes tend to increase more than the average in post-crash market reversals. The
CAPM predicts that stocks with higher betas decrease more in down markets and
increase more in up markets. In line with the prediction of the theory, we find that high
beta stocks lose more value in crashes and gain more value in post-crash market reversals
relative to low beta stocks. In the Fama-French (1992, 1993) three-factor asset pricing
model, smaller firms and those with a low market-to book ratio are riskier investments. In
line with the prediction of the theory, we find that these firms lose more value in stock
market crashes. However, they do not gain more value in post-crash market reversals,
implying that investor reaction against smaller firms and those with lower market-tobook
ratios in stock market crashes is not an overreaction. Our regression results with the
industry dummy variables indicate that investors overbid down the prices of high-tech
stocks in the 1997 crash and manufacturing stocks in the 2008 crash relative to other
stocks. However, the prices of the stocks in these industries increased more than the
prices of the stocks in the other industries in the post-crash market reversals, implying
investor overreaction in these industries in the 1997 and 2008 stock market crashes.Â
Publication Date
January 1, 2015
Citation Information
Daniel Folkinshteyn, Gulser Meric and Ilhan Meric. "Investor Reaction in Stock Market Crashes and Post-Crash Market Reversals" The International Journal of Business and Finance Research Vol. 9 Iss. 5 (2015) p. 57 - 70 Available at: http://works.bepress.com/daniel-folkinshteyn/11/