Stock Market Reactions on Returns and Trading Volume: The Impact of the Global Financial Crisis

Abstract

Objective: This study empirically examines the short term under-and overreaction effect in the Karachi Stock Exchange, Pakistan, in the context of the 2008 Global Financial Crisis considering the period from September 2007 to 2009. Background: Investors' probable reaction to an anticipated or unforeseen event is gaining immense importance in order to understand the complex market behavior. The arrival of good or bad news can tend to bring about a rise or decline in the stock price even if the news does not directly impact company's performance. Method: The sample data for the stock price, trading volume and KSE 100 index are obtained from the Karachi Stock Exchange (KSE) and Securities and Exchange Commission of Pakistan (SECP) websites for the period September 2007 to 2009. To reach our objective, we used event studies. Results: There is evidence of significant overreaction in the first two weeks and significant underreaction in the 12th and 24th week following specifically in the financial sector. For the non-financial sector, the returns stay positive and insignificant for both the winner and loser portfolios thereby negating any evidence of significant overreaction. Contributions: We wants to contribute to the existing literature, testing the under-and overreaction hypothesis in an emerging market. Our study also attempts to draw attention to any evidence of returns reversal in the loser and winner portfolios based on the trading volume. Investors may capitalize on the trading volume information to earn contrarian profits. Keywords: Underreaction; Overreaction; Efficient Market Hypothesis; Event Study; Return Reversals. INTRODUCTIONInvestors' probable reaction to an anticipated or unforeseen event is gaining immense importance in order to understand the complex market behavior. The arrival of good or bad news can tend to bring about a rise or decline in the stock price even if the news does not directly impact company's performance. Such fluctuations in the prices signify certain anomalies that help to understand the irrational behavior of the investors. Therefore, among other possibilities, the market may overall exhibit under reaction or overreaction -a phenomenon that is attributed to the inconsistent investor behavior, which can be associated with events like the international financial crisis. This study attempts to analyze the presence of any such under and overreaction in the short term, in order to better understand the impact and magnitude of 2008 financial crisis, on the Pakistani stock market. It is expected that there was not any severe impact of 2008 crisis on the local economy due to its limited international linkages.The association between stock prices and new information arrival has led towards the development of hypotheses based on the behavioral aspects of investor decision making. For example, the heuristic of anchoring proposes that people often relate themselves to some specific elements or conditions of reference in order to make decisions conveniently. Brown, Harlow, and Tini...

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