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Article
Investor Overreaction to Technical Insolvency and Bankruptcy Risks in the 2008 Stock Market Crash
Journal of Investing (2013)
  • Jia Wang, Rowan University
Abstract
Thaler and De Bondt [1985] demonstrate that investors may overreact to economic events. Studying investor overreaction to economic events has been a popular research topic in finance. However, investor overreaction to certain firm characteristics during economic events has not received sufficient attention. In this article, we study investor overreaction to firm technical insolvency and bankruptcy risks in the 2008 stock market crash. We demonstrate that firms with high technical insolvency and bankruptcy risks lost more value relative to other firms in the 2008 crash. However, these firms gained more value relative to other firms in the post-crash market reversal, implying that investors overreacted to technical insolvency and bankruptcy risks in the 2008 crash. Although firms with a high bankruptcy risk also lost more value in the 1987 stock market crash, these firms did not gain more value relative to other firms in the post-crash market reversal, implying that there was no investor overreaction to bankruptcy risk in the 1987 crash. Lo and MacKinlay [1990] argue that large-firm stock returns respond faster to new information, and large-firm stock returns lead small-firm stock returns. Wang et al. [2009] find support for the Lo-MacKinlay theory with data for eight stock market crashes and post-crash market reversals. In this article, we provide additional empirical evidence on this issue by demonstrating that large-firm stock returns responded faster and led small-firm stock returns in the downward direction in the 1987 and 2008 stock market crashes and in the upward direction in the post-crash market reversals. 
Publication Date
Summer 2013
Citation Information
Jia Wang. "Investor Overreaction to Technical Insolvency and Bankruptcy Risks in the 2008 Stock Market Crash" Journal of Investing Vol. 22 Iss. 2 (2013)
Available at: http://works.bepress.com/jia-wang/8/