Using a comprehensive database of headlines about individual companies, I examine monthly returns following public news. I compare them to stocks with similar returns, but no identifiable public news. There is a di#erence between the two sets. I find strong drift after bad news. Investors seem to react slowly to this information. I also find reversal after extreme price movements unaccompanied by public news. The separate patterns appear even after adjustments for risk exposure and other e#ects. They are, however, mainly seen in smaller, more illiquid stocks. These findings support some integrated theories of investor over- and underreaction.

We review extensive evidence about how psychological biases affect investor behavior and prices. Systematic mispricing probably causes substantial resource misallocation. We argue that limited attention and overconfidence cause investor credulity about the strategic incentives of informed market participants. However, individuals as political participants remain subject to the biases and self-interest they exhibit in private settings. Indeed, correcting contemporaneous market pricing errors is probably not government’s relative advantage. Government and private planners should establish rules ex ante to improve choices and efficiency, including disclosure, reporting, advertising, and default-option-setting regulations. Especially

This paper develops a test of under-reaction to news induced by the presence of investors who display the tendency to realize gains and ride losses, known as the disposition effect. The disposition effect, a widely documented fact in investor behavior, implies that stock prices underreact more to bad news when more current holders are facing a capital loss, and under-react more to good news when more current holders are facing a capital gain. I use a database of mutual funds holdings to construct a measure of reference prices for individual stocks. Using this novel measure of reference price, I show that post-event predictability is most severe when the disposition effect predicts the biggest under-reaction. I show that exposure to a disposition variable spreads the cross-sectional differences in post-event returns: post-event drift is bigger when the news and the capital gains overhang have the same sign and the magnitude of the post-event drift is directly related to the amount of unrealized capital gains (losses) experienced by the stock holders prior to the event date.

We investigate the relation between earnings surprises and post-announcement stock returns for 1991-1997, and show that the profit opportunities previously associated with simple trading strategies designed to exploit the drift phenomenon have now been substantially eliminated. This profitability decline does not appear to be due to increased earnings “noise” from transitory items or to structural changes in the serial correlation of earnings surprises. The post-announcement drift persists where arbitrage costs are highest; that is, among small NYSE/AMEX firms, and among firms with little or no analyst following or with low stock prices. The evidence is consistent with the notion that investors used earnings surprise trading strategies to arbitrage the drift once the phenomenon had been well documented in academic

In this paper we compare and contrast modern finance ( the de facto ruling paradigm of financial economics) with what is being called (most of the time) behavioral finance, and some time “the anomalies literature. ” The faithful of the ruling paradigm have marginalized behavioral finance by making it the “anomalies literature. ” But even the supposed proponents of behavioral finance are marginalizing themselves by clinging to the underlying tenets, forms, and methods of what is now called modern finance. They have allowed it to set the terms of the debate and made it the benchmark against all finance is not only judged, but also labeled “finance. ” But finance research is subject to the same “mistakes ” that behavioral finance attributes to practitioners, and it is these same “mistakes, ” perhaps more than the fierce attacks of the supporters of the ruling doctrine that are preventing behavioral finance from emerging as a new paradigm. In effect, the mere failure of behavioral finance is proof of its veracity and legitimacy. RESISTANCE IS FUTILE: THE ASSIMILATION OF BEHAVIORAL FINANCE I.

Several studies have reported inefficiencies and/or biases in analysts’ability to incorporate new information into their earnings forecasts. We propose that an important psychological factor associated with optimistic earnings forecasts is the propensity of analysts to engage in risky choice behavior as described by prospect theory. Furthermore, the motivational incentives faced by analysts may exacerbate risky choice behavior during forecast revision, thereby magnifying overestimates of earnings. Sixty professional financial analysts were asked to issue a first quarter and then an annual EPS forecast of a company. The analysts were randomly assigned to two initial forecast accuracy conditions that indicated their initial forecast earnings was 1) essentially the same as actual earnings, or 2) substantially higher than actual earnings. Analysts were also assigned to one of three motivational incentive conditions indicating the analyst and brokerage firm would 1) have no future contact with the forecast firm, 2) begin to follow the forecast firm, or 3) establish an underwriting relationship with the forecast firm. The results indicate that analysts who perceived a loss function due to the inaccuracy

Abstract not found

I am submitting herewith a dissertation written by Seung-Woog Kwag entitled “Are

Analyst underreaction to past information about earnings: reporting, processing or plain old misspecification bias? by

ascherbina@hbs.edu. This paper is based on the second part of my Ph.D. dissertation. I would like to thank