Chapter 13
INVESTOR PSYCHOLOGY AND SECURITY MARKET
UNDER- AND OVERREACTION
Kent Daniel, David Hirshleifer,
and Avanidhar Subrahmanyam
In recent yearsa body of evidence on security returns has presented a
sharp challenge to the traditional view that securities are rationally priced
to reflect all publicly available information. Some of the more pervasive
anomalies can be classified as follows (see Hirshleifer 2001 for a summary
of the relevant literature):
- Event-based return predictability (public-event-date average stock
returns of the same sign as average subsequent long-run abnormal
performance) - Short-term momentum (positive short-term autocorrelation of stock
returns, for individual stocks and the market as a whole) - Long-term reversal (negative autocorrelation of short-term returns
separated by long lags, or “overreaction”) - High volatility of asset prices relative to fundamentals
- Short-run post-earnings announcement stock price “drift” in the di-
rection indicated by the earnings surprise, but possible abnormal
stock price performance in the opposite direction of long-term earn-
ings changes.
There remains disagreement over the interpretation of the above evi-
dence of predictability. One possibility is that these anomalies are chance
We thank two anonymous referees (Journal of Finance, volume LIII, Number 2, December
1918–83), the editor (René Stulz), Michael Brennan, Steve Buser, Werner DeBondt, Eugene
Fama, Simon Gervais, Robert Jones, Blake LeBaron, Tim Opler, Canice Prendergast, Andrei
Shleifer, Matt Spiegel, Siew Hong Teoh, and Sheridan Titman for helpful comments and dis-
cussions, Robert Noah for excellent research assistance, and participants in the National Bu-
reau of Economic Research 1996 Asset Pricing and 1997 Behavioral Finance Meetings, the
1997 Western Finance Association Meetings, the 1997 University of Chicago Economics of
Uncertainty Workshop, and finance workshops at the Securities and Exchange Commission
and the following universities: University of California at Berkeley, University of California at
Los Angeles, Columbia University, University of Florida, University of Houston, University of
Michigan, London Business School, London School of Economics, Northwestern University,
Ohio State University, Stanford University, and Washington University at St. Louis, for helpful
comments. Hirshleifer thanks the Nippon Telephone and Telegraph Program of Asian Finance
and Economics for financial support.