Overreact, over-react, to information. Investor overreaction is an emotional response to new information about a market or security that is driven by greed or fear.
Investors overreacting to news may cause the security, stock, or market to become overbought or oversold until it returns to a more normal range.
Overreact is to respond more emotionally or forcibly than is justified.
Investors are not always rational the rational actors assumed by earlier economists. Instead of perfectly and instantly pricing in all information perfectly, as the Efficient Market Hypothesis assumes, investors and traders are driven by their emotion and faulty cognitive and behavioral biases.
Investor overreaction and underreaction are a challenge to the Efficient Market Hypothesis in that investors often overreact or underreact to the news. If overreactions and underreactions were symmetrical, these reactions could still be consistent with the Efficient Market Hypothesis. However, investor behavior suggests that there are systematic patterns of overreaction and underreaction. For example, individuals tend to anchor to their beliefs, so they underreact to the news. On the other hand, information that is prominent gets people’s attention so they give it more weight in their decision-making process and in forming new beliefs, resulting in over-reaction. Therefore, price prices stray from their rational value, higher or lower, over periods of time. Becuase of underreaction, prices drift gradually up and down, causing what see observe as price trends.
‘…investors overreact to negative news.’
‘De Bondt and Thaler argued that investors overreact to both bad news and good news. Therefore, overreaction leads past losers to become underpriced and past winners to become overpriced.’
‘De Bondt and Thaler predicted overreaction based on representativeness. […] a portfolio of extreme losers does outperform the market. However, a careful inspection of the figure shows that the effect is concentrated in the month of January.’
Shefrin (2000) page 42
‘Fama (1998a, 1998b) argues that “apparent overreaction of stock prices to information is about as common as underreaction.’
Shefrin (2000) page 87
‘Rather, what we find is apparent underreaction at short horizons and apparent overreaction at long horizons.’
Shefrin (2000) page 87
‘What we seem to have is overreaction at very short horizons, say less than one month (Lehmann, 1990), momentum possibly due to underreaction for horizons between three and twelve months (Jegadeesh and Titman 1993) and overreaction for periods longer than one year (De Bondt and Thaler 1985, 1987, 1990).’
Shefrin (2000) page 85
‘The overreaction evidence shows that over longer horizons of perhaps three to five years, security prices overreact to consistent patterns of news pointing in the same direction.’
Shleifer (2000) page 112
Overreaction cited in articles and papers:
- ABARBANELL, Jeffry S. and Victor L. BERNARD, 1992. Tests of Analysts’ Overreaction/Underreaction to Earnings Information as an Explanation for Anomalous Stock Price Behavior [about 93]
- AIYAGARI, S. Rao and Mark GERTLER, 1999. ��Overreaction�� of Asset Prices in General Equilibrium [about 151]
- ANTONIOU, Antonios, Emilios C. GALARIOTIS, and Spyros I. SPYROU, 2001. Contrarian Profits and the Overreaction Hypothesis: The Case of the Athens Stock Exchange 
- BARBERIS, Nicholas, Andrei SHLEIFER and Robert VISHNY, 1998. A Model of Investor Sentiment [about 516]
- BARBERIS, Nicholas, Andrei SHLEIFER and Robert VISHNY, 1998. A model of investor sentiment [about 516]
- BAYTAS, Ahmet and Nusret CAKICI, 1999. Do markets overreact: International evidence [about 11]
- BERNSTEIN, Peter L., 1985. Does the Stock Market Overreact?: Discussion 
- BOWMAN, Robert G. and David IVERSON, 1998. Short-run overreaction in the New Zealand stock market 
- CAGINALP, Gunduz, David PORTER and Vernon SMITH, 2000. Momentum and overreaction in experimental asset markets [about 28]
- CONRAD, Jennifer and Gautam KAUL, 1993. Long-Term Market Overreaction or Biases in Computed Returns? [about 72]
- De BONDT, Werner F. M. and Richard H. THALER, 1987. Further Evidence on Investor Overreaction and Stock Market Seasonality[about 228]
- De BONDT, Werner F. M. and Richard H. THALER, 1990. Do Security Analysts Overreact? [about 168]
- De BONDT, Werner F. M. and Richard THALER, 1985. Does the Stock Market Overreact? [about 805]
- DIACOGIANNIS, G.P., et al., 2005. Price limits and overreaction in the Athens stock exchange. Applied Financial Economics. [not cited]
- DREMAN, David N. and Eric A. LUFKIN, 2000. Investor overreaction: Evidence that its basis is psychological, The Journal of Psychology and Financial Markets, Vol. 1, No. 1, 61-75. [Cited by 8] (1.27/year)
- FAMA, Eugene F., 1998. Market efficiency, long-term returns, and behavioral finance [about 647]
- FULLER, Russell J., 2000. Behavioral Finance and the Sources of Alpha [about 28]
- GAUNT, Clive, 2000. Overreaction in the Australian equity market: 1974-1997 
- HAUGEN, R.A., 2004. The new finance: overreaction, complexity, and uniqueness. Upper Saddle River, NJ: Pearson/Prentice Hall. [Cited by 1]
- HONG, Harrison and Jeremy C. STEIN, 1997. A Unified Theory of Underreaction, Momentum Trading and Overreaction in Asset Markets[about 385]
- HONG, Harrison and Jeremy C. STEIN, 1999. A Unified Theory of Underreaction, Momentum Trading, and Overreaction in Asset Markets [about 385]
- JEGADEESH, Narasimhan and Sheridan TITMAN, 1993. Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency [about 748]
- JEGADEESH, Narasimhan and Sheridan TITMAN, 1995. Overreaction, Delayed Reaction, and Contrarian Profits [about 94]
- JOHNSSON, Malena, Henrik LINDBLOM and Peter PLATAN, 2002. Behavioral Finance – And the Change of Investor Behavior during and After the Speculative Bubble At the End of the 1990s [about 3]
- LARSON, Stephen J. and Jeff MADURA, 2001. Overreaction and underreaction in the foreign exchange market, Global Finance Journal 12 (2001) 153�177 
- LEHMANN, Bruce N., 1993. Fads, Martingales, and Market Efficiency [about 154]
- LO, Andrew W. and A. Craig MacKINLAY, 1990. When are Contrarian Profits Due to Stock Market Overreaction? [about 268]
- LOUGHRAN, Tim and Jay R. RITTER, 1996. Long-Term Market Overreaction: The Effect of Low-Priced Stocks, Journal of Finance, Volume 51, Issue 5 (Dec., 1996), 1959-1970. [about 34]
- MASSEY, C. and G. WU, 2005. Detecting regime shifts: The psychology of under-and overreaction. Management Science. [Cited by 1]
- MICHAELY, Roni, Richard H. THALER and Kent L. WOMACK, 1995. Price Reactions to Dividend Initiations and Omissions: Overreaction or Drift? [about 135]
- MUN, Johnathan C., Geraldo M. VASCONCELLOS and Richard KISH, 2000. The Contrarian/Overreaction Hypothesis An analysis of the US and Canadian stock markets 
- NAM, Kiseok, Chong Soo PYUN and Stephen L. AVARD, 2001. Asymmetric reverting behavior of short-horizon stock returns: An evidence of stock market overreaction [about 12]
- OFFERMAN and SONNEMANS, 2000. What’s Causing Overreaction? An Experimental Investigation of Recency and the Hot Hand Effect [about 15]
- POTESHMAN, 2000. Underreaction, Overreaction, and Increasing Misreaction to Information in the Options Market [about 55]
- POWER, D. M. and A. A. LONIE, 1993. The Overreaction Effect: Anomaly of the 1980s? 
- RATNER and LEAL, 1998. Evidence of Short-Term Price Reversals Following Large One Day Movements in the Emerging Markets of Latin America and Asia
- SEYHUN, 1990. Overreaction or Fundamentals: Some Lessons from Insiders’ Response to the Market Crash of 1987
- SHEFRIN, Hersh, 2000. Beyond Greed and Fear : Understanding Behavioral Finance and the Psychology of Investing.
- SKERRATT, 2000. Behavioural explanations for under and overreaction
- SKERRATT, 2000. Are analysts responsible for post earnings announcement drift and other anomalies that suggest that the market generally adjusts inadequately to new information?
- SKERRATT, 2000. Do analysts overreact to information?
- THEOBALD, Michael and Peter YALLUP, Determining security speed of adjustment coefficients
- VERONESI 1999. Stock Market Overreaction to Bad News in Good Times: A Rational Expectations Equilibrium Model [about 110]
- WANG, J., et al., 2004. Analysis of the overreaction effect in the Chinese stock market. Applied Economics Letters. [Cited by 1]
- XIANG, HE and CAO, 2002. Continuous overreaction, insiders trading activities and momentum strategies 
- ZAROWIN, Paul, 1990 Size, Seasonality, and Stock Market Overreaction, The Journal of Financial and Quantitative Analysis, Vol. 25, No. 1. (Mar., 1990), pp. 113-125.