On Investors Reaction to Market Surprises: Evidence from the Chinese Market

Abstract

This paper examines the reaction of investors to the arrival of unexpected information in the Chinese equity market. Market surprises are identified using a strictly quantitative approach, and cumulative abnormal returns are calculated and tracked for a period of 30 days after each favorable or unfavorable event.

The empirical results provide evidence to show that investors’ reactions are consistent with the prediction of the Uncertain Information Hypothesis in the Chinese equity markets. Following market surprises, both the risk and the expected return of the affected market increase systematically. Rational investors, attempting err on the side of caution, set security prices below their fundamental values. Further clarifications of the uncertainty results in positive, or at least non-negative, price adjustments. One of the major implications of these results for investors is that implementing a contrarian strategy of buying current losers and selling current winners may not generate superior returns on the Chinese market. On the other hand, the phenomena of positive, or at least non-negative, price adjustments after surprises suggest that an investment strategy of buying immediately after market surprises may generate superior returns on the market.

Keywords: Efficiency, Rational Investors, Uncertainty

JEL Classification: G14, G15