What is Abnormal in Abnormal Returns?
DOI:
https://doi.org/10.55737/rl.2025.41191Keywords:
Abnormal Returns, Cumulative Abnormal Returns, Private Information, Reference Points, Anchoring, Over-React, Under-ReactAbstract
This study investigates how investors determine stock prices after large stock prices shocks in Pakistan Stock Exchange (PSX) over the time period of January 2021 to December 2025. Building on behavioral finance theories of anchoring and underreaction of investors, it examines whether returns after a shock are indicative of reference point and private information signaling instead of immediate and full incorporation of public information. Using an event study approach coupled with panel regressions, this study examines 21 firms from various industries and control for raw returns, trading volume, momentum effects and day-of-the-week anomalies. Large price shocks are defined as extreme daily returns above a given percentile and abnormal returns are analyzed both pre and post shock. The results show that the abnormal returns before the shock tend to be in the opposite direction of the event-day movement, implying the diffusion of information. Following the shock, there is significant continuation of returns in the direction of the first price movement consistent with the anchoring and delayed belief updating. These findings suggest that investors are initially either underreacting or overreacting to new information but improve their expectations, thus predictably resulting in return patterns. Overall, the evidence is suggestive that the PSX has short-term market inefficiencies following excessive price movements. The results add to the behavioral asset pricing literature by illuminating the role played by reference dependence in emerging markets, while suggesting the existence of exploitable abnormal returns following large shocks.
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