Short Run Stock Overreaction: Evidence from Bursa Malaysia NORLI ALIa*, ANNUAR MD NASSIRb , TAUFIQ HASSANc AND SAZALI ZAINAL ABIDINd a*Universiti Teknologi MARA b,c,dUniversiti Putra Malaysia ABSTRACT The objective of this paper is to discuss evidence of short run stock overreaction with respect to the arrival of dramatic events in the Malaysian stock market. The findings reveal that Malaysian stock market overreacts to economic crisis and extraordinary political events. The study shows significant overreaction behaviour existed in this market upon announcement of the removal of the deputy prime minister and announcement of the resignation of the prime minister. In contrast, evidence of underreaction was detected upon announcement of the national election. With regards to dramatic international events, Malaysian stock markets only disclose evidence of stock overreaction behaviour to SARS outbreak. Keywords: Stock overreaction, EMH, Bursa Malaysia

INTRODUCTION Fama (1970) defines stock market as efficient if stock prices fully reflect all available information. This definition implies that the available information cannot be used to forecast stock prices in a fully efficient market. It is due to the reason that the current market price of a stock is the best estimates of its value and therefore should reflect all available relevant information. The price of a stock as well, is expected to change immediately and unbiasedly upon the arrival of new information. However, many published works (De Bondt and Thaler, 1985, 1987; Fung, 1999; Gaunt, 2000; Lai, et al., 2003 and Iihara et al., 2004) found evidence suggesting that over the long run, some predictability may exist in stock returns. These long term and

Any remaining errors or omissions rest solely with the author(s) of this paper.320 International Journal of Economics and Management short term behaviour in returns is often characterized as evidence of overreaction and under reaction by market participants. Majority of studies in these areas have been performed in the US and UKs market. Until recently, there are a few studies related to these issues are documented for the Malaysian stock market (Lai, et al, 2003; Ahmad and Hussain, 2001and Hameed and Ting (2000). The objective of this paper is to investigate evidence of stock overreaction upon arrival of extraordinary events in the Malaysian stock market. This paper is divided into six sections. Section two will briefly discuss the idea of stock overreaction and its implications to EMH while section three talks about stock overreaction behaviour and the arrival of dramatic events. Section four and five elaborate the methodology and findings of this study respectively. Section six summarizes the study. STOCK OVERREACTION AND IMPLICATIONS TO EMH Overreaction is a notion which suggests that, like human behaviour, stock price also has a tendency to overreact to extremely good and bad news. This behaviour is generally resulting from market participants who overreact to the arrival of the new dramatic event but correct their behaviour later. Such market overreaction behaviour proposes that stocks that perform best (worst) over an initial period tend to perform worst (best) in the subsequent period. One strategy that is synonym with stock overreaction is the Contrarian Strategy. The contrarians assume that market overreacts to events in such a way that extremely negative news pulls the stock very much below its true value and extraordinary positive news push the stocks price well above its fair value. This is due to the reason that investors tend to overreact to extreme information that it generate such price movements that go beyond the new justified equilibrium level. Later, as investors realize that they have unduly reacted to the information and take corrective action, price will change to the opposite direction of the initial movements and approached its true equilibrium level. This phenomenon suggests that there is some predictability exists in stock market where loser (winner) firms in one period are likely to win (lose) in the subsequent period. So, strategy that based on Overreaction Hypothesis such as contrarian strategy of buying loser firms and selling winner firms is able to consistently earned potential abnormal returns. Consistent abnormal profits earned by such strategies appear inconsistent with market efficiency, in which, it violates the weak form market efficiency. EMH argues that current prices formed in a competitive and well-regulated market place reflect all known relevant information. According to Ariff, Shamsher and Annuar (1998), it is not possible to make consistent predictions about how future prices will move based on past price patterns. It is because, price changes are not due to stock overreaction and underreaction, but are due to new information, which includes new interpretation of existing information, given more recent developments. Therefore, knowing 321 Short Run Stock Overreaction: Evidence from Bursa Malaysia historical price data will not enable investors to consistently earned abnormal returns. However, as mentioned above, many studies have documented the existence of stock overreaction behavior in various stock markets. If stock overreaction exist in Bursa Malaysia, then it would be possible to predict future prices based upon past price information to earn excess profit. This also means that stock prices on Bursa Malaysia will not be in its weak form efficiency if the evidence supports the overreaction or underreaction hypothesis. STOCK OVERREACTION AND THE ARRIVAL OF NEW INFORMATION In an efficient market, stock price is expected to adjust rapidly and accurately to its new equilibrium level upon arrival of new information. Besides financial information, news about political, economic and social events will also be reflected in the stock prices. It is worth to note that the efficiency of the stock market depends on how investors deduce and react towards such events. If investors overreact towards such information, stock price will overshoots its target equilibrium level, and is expected to revert to its true equilibrium level in the subsequent period. There are a number of studies has been conducted such as Zhu (2007), Ising et. al (2006) and Michayluk and Neuhauser (2006) among others to test if stock price has overreacted towards arrival of new information. Most of these studies have focused on stock market returns following extraordinary price movements (either large price increase or large price declines). There is no study thus far that directly focused on stock overreaction behaviour upon arrival of specific events. However, one stream of research related to stock market reaction, although it is not directly related to stock overreaction hypothesis (such as Bilson, Brailsford and Hooper, 2002; Bialkwoski, Gottschalk and Wisniewski, 2008; Maloney and Mulherin, 2003 among others) concentrates on extreme and dramatic events. Such extreme and dramatic events include stock market crashes, political events, and catastrophic events like earthquakes, terrorist attacks, war and many more. Their studies mostly ponder around price discovery, valuation and volatility of stock prices. Findings from their studies show significant impact of extreme events on market reaction. Bursa Malaysia, being an emerging market will be affected by price over and underreaction in response to such events. Such unexpected events can create stress in the stock market and consequently, may cause market participants to lose their ability to rationally assess the valuation implication of the events, which may results in stock overreaction and underreaction behaviour. In Malaysia, Jothee and Annuar (2007) however have performed a study to measure the speed of price adjustment to corporate announcements while Otchere and Chan (2003) look into the stock overreaction behaviour in Hong Kong stock market around the period of 1997 Asian Financial Crisis. Jothee and Annuar (2007) confirm that there is evidence of price overreaction to new information in Bursa Malaysia. 322 International Journal of Economics and Management This current study divides extreme events into three categories namely domestic events, international events and economic events. Domestic events will comprise of general elections, resignation of the Malaysian Prime Minister and removal of the deputy prime minister of Malaysia. Gulf Crisis, Invasion of Iraq, Sept 11th terrorist attacks on US, Severe Acute Respiratory Syndrome (SARS) and Asian Tsunami are group into international events while 1987 Financial Market Crisis and Asian Financial Crisis into economic events. The reason why this study uses political events to represent domestic events is because in Malaysia, political involvement is very strong such that business and politics are interrelated. According to Chen (2005), about 20% of market capitalization in Malaysia comprised of politicallylinked firms.

Therefore, surprise in political news may have an impact on investors overreaction behaviour. Moreover, study by Bilson, Brailsford and Hooper (2002) prove that political risk may be able to explain some of the variation in emerging market returns. If political risk is important in explaining returns variation in emerging market, then it may have influence on investors overreaction behaviour. In another study, Bialkowski, Gottschalk and Wisniewski (2008) find evidence that investors are surprised by the election outcome, thus suggesting that general election may be able to explain overreaction behaviour of the stock market. Economic events such as market crash and crisis are also considered as important factor in the study of stock overreaction hypothesis. Previous studies like Michayluk and Neuhauser (2006) and Otchere and Chan (2003) have found that stock market tend to overreact in times of crisis. Besides economic events like market crash and crisis, security prices are also reacting to catastrophic events. Studies on stock price reaction to disaster have been conducted by Maloney and Mulherin (2003), and Shelor, Anderson and Cross (1990) among others. Their findings suggest that security prices has significantly reacts to such events. If catastrophic events have an impact on stock reaction, price discovery and valuation as presented by the above researches, it may have an influence on the behaviour of stock market in the context of stock overreaction hypothesis. For the purpose of this study, dramatic events namely Severe Acute Respiratory Syndrome (SARS), Asian Tsunami, Sept 11th terrorist attack, Gulf Crisis, Invasion of Iraq on Kuwait have been chosen to represent international events as these events occurs at the international level. This study investigates investors overreaction behaviour to catastrophic events namely SARS outbreak and Asian Tsunami because these two devastating events had greatly affected the economy of the affected area and thus might as well affect the behaviour of their respective investors. Meanwhile, invasion of Iraq and the Gulf crisis involves oil producing country and therefore will have an effect on oil prices. It is well known that oil prices play an important role in stock pricing and thus might influence investors behaviour. Findings from this study will have an important implication for the strategies of institutional and individual investors.

SUMMARY

This study find that Malaysian stock market has significantly overreacts to economic events. Findings of the study have documented significant evidence of stock overreaction where loser has significantly outperformed winner in both periods. These results suggest that investors overreact to abnormal economic activity. During this period of time, a series of positive news about a stock might have boosted investors confidence and thus causing them to highly overvalue the securities. Once they realized of the overvaluation, and take corrective action, stock prices reverse in the subsequent period. The opposite is true for a series of negative news.

The study also finds that Bursa Malaysia overreacts to surprises in political news. Unexpected events namely the removal of the DPM and resignation of PM have caused investors to overreact. Well announced events like announcement of general election appear not to significantly caused investors overreaction behaviour in the stock market. Unlike test for economic and domestic events that support stock overreaction behaviour in Bursa Malaysia, those of international events present mixed results. The study shows that Malaysian stock market has significantly overreact to SARS outbreak, while significantly underreact to September 11th terrorist attacks. Although Gulf Crisis and Invasion of Iraq involve oil producing country, surprisingly, Malaysian stock market does not show any evidence of stock overreaction behaviour towards those events. Overall, evidences of short term behaviour presented by this study propose that Bursa Malaysia is not consistent with the weak form of EMH in the short run. The results show that investors are able to earn abnormal profit by selling past winners and buying past loser upon surprises in political news and economic crisis for example. In addition to that, arbitrage strategy of buying past winner and selling past loser will give potential abnormal profit to investors upon announcement of general election. Therefore, this study suggest that knowing past performance of stocks enabled investors to beat the market when there is a surprise in information. So, this study concludes that Malaysian stock market is not weakly efficient in the short run.

QUESTION

Review of the Literature (1 2 pages) i. Are the cited sources relevant to the study? ii. Is the review too broad or too narrow? iii. Are the references recent? iv. Is there an evidence of bias?