An Empirical Study On China's Stock Market Overreaction

Recently behavioral finance attracts more and more attention. Overreaction is one of hot issues in behavioral finance. More and more theories and empirical results have been achieved.The relevant study in China, however, still lacks enough empirical study based on local data. By the method of case study, we test whether Chinese stock market overreacts on the basis of recent discoveries as well as the data of stock market trading in CSMAR. On the whole, the paper documents a significant overreaction in China stock market. There is an overreaction to earning information, which might be caused by the investor intrinsic psychological momentum and investment inclination not the risk difference.The summary makes a systematical review of existent domestic and foreign theories relevant with overreaction: pre-period return theory, risk theory, size theory , bid-ask theory and the theory of overreaction to earning information. Furthermore, it introduces the contrarian strategy based on overreaction theory at the same time.The first empirical paper sorts all the stocks according to the past accumulated abnormal return. The winner is those who perform best while the loser is those who perform worst. By reviewing the accumulated abnormal return changing tendency in both the winner and loser during testing period, the paper finds a better performance in the loser than in the winner. There is a long-term automatic reversion in China stock market. The empirical results supports the overreaction hypothesis.In the second empirical paper, the earnings announcements are chosen as the events for testing whether Chinese stock market overreacts to the earnings information. The former index considers more of the earning variability and uncertainty and is calculated based on the absolute value and standard deviation of three-year earning change in the listed companies. However the testing results don't support the overreaction hypothesis because most of companies are newly listed. Therefore, we rechoose the index which considers more of the investor psychological sense. We make a redivision and retest based on the mean of earning per share and find that the result supports the overreaction hypothesis. Hereafter, we research the overreaction in different industries and document a less significant overreaction in the high-growth and high risk industries than in traditional industries, which might due to the lack of sample.The third empirical paper builds up an arbitrage portfolio and analyzes the value of the loser and winner during testing period. It finds that the risk difference between the winner and loser can't explain the its accumulated abnormal return difference. The separate regression on the up and down periods testifies fatherly that the risk difference isn't the main cause for overreaction.