The Effects of Overreaction to Bad News
Flaugher, Brad J.
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Psychological evidence and casual intuition predict that humans tend to overreact to bad news. This paper examines responses to bad news and their effects in financial markets. If news is sufficiently bad, the market tends to overreact and stock returns tend to be positive for one to two days following the announcement of bad news. After three days stocks trend downwards, which is in agreement with past observations of post earnings announcement drift. Insider trading or information leakage was also observed in the data. These results are difficult to reconcile with theories of rational price-setting.