Overreaction to Stock Market News and Misevaluation of Stock Prices by Unsophisticated Investors: Evidence from the Option Market

39 Pages Posted: 7 Jul 2004

See all articles by Allen M. Poteshman

Allen M. Poteshman

University of Illinois at Urbana-Champaign - Department of Finance

Reza S. Mahani

Georgia Tech Finance/Scheller

Date Written: November 21, 2004

Abstract

This paper examines option activity on value and growth stocks before earnings announcements. The main finding is that unsophisticated investors enter option positions that load up on growth stocks relative to value stocks in the days leading up to earnings announcements. This occurs despite the fact that at earnings announcements value stocks outperform growth stocks by a wide margin. The paper's results provide evidence that unsophisticated option market investors (1) overreact to past news on underlying stocks and (2) mistakenly believe that mispriced stocks will move even further away from fundamentals at impending scheduled news releases.

Keywords: overreaction, value versus growth, option market, unsophisticated investors

JEL Classification: G12, G14

Suggested Citation

Poteshman, Allen M. and Mahani, Reza S., Overreaction to Stock Market News and Misevaluation of Stock Prices by Unsophisticated Investors: Evidence from the Option Market (November 21, 2004). Available at SSRN: https://ssrn.com/abstract=473263 or http://dx.doi.org/10.2139/ssrn.473263

Allen M. Poteshman (Contact Author)

University of Illinois at Urbana-Champaign - Department of Finance ( email )

340 Wohlers Hall
1206 South Sixth Street
Champaign, IL 61820
United States
217-265-0565 (Phone)
217-244-3102 (Fax)

HOME PAGE: http://www.business.uiuc.edu/poteshma

Reza S. Mahani

Georgia Tech Finance/Scheller ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States

HOME PAGE: http://scheller.gatech.edu

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