A Re Examination of the Over-Reaction Hypothesis in the Equity Market: Australian Evidence 1980 to 1997

Abstract

The inconclusive nature of the over-reaction hypothesis, combined with an inherent difficulty in isolating specific determinants, has meant that the controversy surrounding this model has been perpetuated within the financial economics literature. It is the objective of this study to examine whether over-reaction is present in the Australian stock market over the period 1980-1997. The results from this study raise new questions about the relevance of the over-reaction hypothesis to the Australian market. The over-reaction hypothesis suggests that if investors over-react then a contrarian strategy of buying losers and selling winners, should earn significant abnormal returns. The results in our study show that winners experience a reversal and losers continue to be losers. Further, this study extends the current literature by examining reversal behaviour at an aggregate industry level and disaggregated sector level. Evidence is found of sector reversal that is time varying. No evidence is found to support persistent over-reaction.

Keywords: Over-reaction hypothesis, Contrarian, Reversal Behaviour, Risk Premia

JEL Classification: G140