Investor overreaction and global financial crisis: A case of Pakistan stock exchange

Abstract

Recently, the investor overreaction catches the attention of the academicians and practitioners. The topic comes under the limelight of academicians and policymakers. This study, therefore, addresses investor overreaction and its relationship with the global financial crisis for the period of 2004–15. The study used stratified random sampling technique; equal allocation method of Krejcie and Morgan. By adopting the methodology of Debondt and Thaler, the study finds that there is highly significant overreaction (distinct reversal) in the stock market in the global-financial crisis period, which may attribute to the aggressive behavior of individual investors in the market. Overreaction has also been shown in the line graph shaded area which opposes the efficient market hypothesis and verifies the presence of a weak form of efficiency. Econometric tests are applied for robustness check that confirms weak form of efficiency in the PSX. The study has implications for both the investors and policymakers. This study is quintessential for those investors who have the aptitude to look introspectively and to evaluate their behavioral biases. Further, investors would learn to transmute behaviors and to build portfolios which will help them to stick to their long-term investment strategies and hence achieve their investment goals.

Keywords:

• Overreaction
• underreaction
• portfolios
• Pakistan stock exchange

PUBLIC INTEREST STATEMENT

This research is an application of behavioral finance on the real-world problems. It explains that stock markets are exposed to investors’ biases that subject to the spill-over effect of other stock markets. The scholars interested in the realm of behavioral finance can use our findings in their research for in-depth insights. Every investor trading in the stock market suffers biases in short-run, while return to normal position later on shows overreaction, that is, showing more aggressive behavior in the market. If investors face bad news that directly affect the investors’ behavior in negative way, it results in irrational decisions. More specifically this paper investigated the impact of global financial crisis on the investors’ decisions in the stock market of Pakistan. The study highlighted the issue that investors in the stock market possess less information. Further, they do not make rational decisions in short-run in the market, which consequently leads to investor overreaction.

Cover Image

Source: Author.

Notes

1. ACARs are Average Cumulative Abnormal Returns mentioned in the concerned study which have been properly carried out in methodology section of the paper. For further explanation, the researcher first collected closing prices of firm securities listed on Pakistan Stock Exchange and the Actual Returns were calculated for those stocks. Later on the Abnormal Returns (ARs) and the Cumulative Abnormal Returns (CARs) were calculated. At the end, average was found out for the Cumulative Abnormal Returns.

2. Table A is the table with alphabet name and it shows the selected companies detail.

3. In the line-graph in Figure 1 first row 1, 2, 3, … … 11, and 12 are the weeks picked up from the concerned period which exist in the pre-crisis period (2004–06).

4. In the line-graph in Figure 2 first row 1, 2, 3, … … 11, and 12 are the weeks picked up from the concerned period which exist in the global financial crisis period (2007–09).

5. In the line graph in Figure 3 first row 1, 2, 3, … … 11, and 12 are the weeks picked from the concerned period which exist in the post-global financial crisis period (2010–12).

6. In the line graph in Figure 4 in first row 1, 2, 3, 4, … … 20, and 21 are the weeks picked from the concerned period which exist in the whole time period of the study (2004–15).

Additional information

Funding

The authors received no direct funding for this research.

Notes on contributors

Rizwan Ullah

Bahrawar Said is currently working as a Lecturer at Department of Commerce and Management Sciences at University of Malakand. Previously, he had been a visiting Lecturer at Grafton University College Islamabad (2016–17) and then joined Civil Secretariat Planning and Development Department as a Development Officer (2017–18). Additionally, in his MS degree, he worked on “behavioural finance and stock market efficiency”. Now, he is a PhD scholar. His PhD research is mainly focused on market microstructure, financial reforms and market efficiency.