Sensitivity of Investor Reaction to Market Direction and Volatility: Dividend Change Announcements

Abstract

We examine whether investor reactions are sensitive to the recent direction or volatility of underlying market movements. We find that dividend-change announcements elicit a greater change in stock price when the nature of the news (good or bad) goes against the grain of the recent market direction during volatile times. For example, announcements to lower dividends elicit a significantly greater decrease in stock price when market returns have been up and more volatile. Similarly, announcements to raise dividends tend to elicit a greater increase in stock price when market returns have been normal or down and more volatile, although this latter tendency lacks statistical significance. We suggest an explanation for these results that combines the implications of a dynamic rational expectations equilibrium model with behavioral considerations that link the responsiveness of investors to market direction and volatility.

Keywords: Dividend announcements, rational expectations

JEL Classification: G14, G19