How does the stock market absorb shocks?

Murray Z. Frank, Ali Sanati

Research output: Contribution to journalArticlepeer-review

18 Scopus citations

Abstract

Using a comprehensive set of news stories, we find a stark difference in market responses to positive and negative price shocks accompanied by new information. When there is a news story about a firm, positive price shocks are followed by reversal, while negative ones result in drift. This is interpreted as the stock market overreaction to good news and underreaction to bad news. These seemingly contradictory results can be explained in a single framework, considering the interaction of retail investors with attention bias, and arbitrageurs with short-run capital constraints. Consistent with this hypothesis, we find that both patterns are stronger when the attention bias is stronger, and when the arbitrage capital is scarce.

Original languageEnglish (US)
Pages (from-to)136-153
Number of pages18
JournalJournal of Financial Economics
Volume129
Issue number1
DOIs
StatePublished - Jul 2018
Externally publishedYes

Bibliographical note

Publisher Copyright:
© 2018

Keywords

  • Limited attention
  • Limits to arbitrage
  • News
  • Overreaction
  • Stock return predictability
  • Text analysis
  • Underreaction

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