International Journal of Business and Social Science

ISSN 2219-1933 (Print), 2219-6021 (Online) DOI: 10.30845/ijbss

Investors Irrationality in the US Equity Market: The Overreaction Effect
Sam Harger, Ahmed Elshahat, Philip A. Horvath

This paper focuses on the equity prices overreaction. Using a sample of all actively traded securities in the US equity markets, this paper assesses the investors’ irrationality by calculating the returns associated with a contrarian trading strategy in different market segments. We utilized an improved methodology for calculating the over-reaction trade, namely, the counter-party swaps. The results show significant levels of profitability in the equity market as a whole, and distinct differences in magnitude and profitability when comparing specific market segments. Equity market segments like the S&P500, with brand name stocks, revert to their fundamental values faster relative to the market as a whole. That means that those segments exhibit less overreaction, which can be justified by the larger number of analysts and investors monitoring these stocks. This paper also offers theoretical justification for the investors’ overreaction, using the expected utility theory’s plunging and dumping.

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