Short-term market reaction after extreme price changes of liquid stocks
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Transcript of Short-term market reaction after extreme price changes of liquid stocks
Short-term market reaction after extreme price
changes of liquid stocks
Introductionprice evolution of liquid stocks after large
intraday price changeSignificant reversalVolatility and volume stay highNYSE-widen bid-ask spreadNASDAQ-almost constant bid-ask spread
NYSE versus NASDAQAble to adjust for dividend & stock split
No dividend & stock split info
Includes all transactions and the best bid-ask spread
Computer based-occasionally single transactions filed outside bid-ask spread
Trading data from 0930-1600
Trading data from 0930-1600
Defining Large Price ChangesAbsolute Filter
Intraday price change > 2-6% within 10-120 mins
Relative FilterPrice move exceeding 6-
10 times the normal volatility during that time of the day
Omit first 5mins and last 60mins of trading
Calculation of AverageCalculate average minute volatility, trading
volume and bid ask spread based on 60 pre-event trading days
• Compare volatility, volume and spread with pre-event minute average.
BetaMeasure of volatility of a portfolio in
comparison to the marketCalculated using daily stock prices and index
changes of the 60 pre event trading daysBeta may change after large price shocksPost-event abnormal return calculated using
beta computed using 60 post-event trading days
Results-Intraday Price ReactionSignificant reversal 10-60mins after eventFaster reversal for price increasesPrice reversal is bigger for decreases after
30-60mins intervalAbnormal return =
Raw return – (beta * index return)AR and RR very close
Price Reversal
NYSE price evolution
NASDAQ price evolution
Stability of Price ReversalSize of filter does not affect existence of overreaction
60-minute long price drops exceeding 2-6% and 6-10 times the average 60-minute volatility
Length of price drop affects validity of results10-minute to 120 minute long price drops exceeding 4% and
8 times the average “Intraday reversal puzzle”
Chartist traders overreact irrationally compared to fundamentalist traders, which lead to pricing error that is later reversed.
Natural consequence of the existence of informed and uninformed traders.
Linear relationship between size of original price drop and size of rebound.
60-min raw returns after intraday 60-min price drops exceeding 2-6% and 6-10 times average 60-min volatility
60-min raw returns after intraday 10-120-min price changes exceeding 4% and 8 times the average 10-12-min volatility
Evolution of volatility and volumeTransaction dollar volume increase sharply at
even up to 8-9 times of its value during pre-event days.
Volume and volatility decrease only very slowly after the event.
Decrease of post-event excess volatility well fitted by power-law, but not volume.
Volatility from extreme events decay faster than autocorrelation, possible due to large shocks being more likely to be exogenous than all fluctuations.
Bid-ask spread stays virtually unchanged on the NASDAQ but increases to 6 times its pre-event value on NYSE.
Evolution of volatility and volume on NYSE and NASDAQ
Decay of Volatility on NASDAQ
Decay of Volume on NASDAQ
Evolution of bid-ask spread on NYSE and NASDAQ
Profitability of Contrarian Strategies
Contrarian trading strategy yields significant abnormal profit on NASDAQ during the post-event 30-60 min by buying at ask price at min 0 and selling at bid at min 30.
Profits are lower or insignificant on NYSE due to wide bid-ask spread.
Not true that profits on NASDAQ can only be acquired by traders who are amazingly fast.
Profits limited by number of shares available at the best bid and ask price but significantly larger than 0.
Further studies should examine exact profitability taking into account transaction costs and costs of monitoring.
Contrarian Trading StrategyStrategy when an investor attempts to profit
by going against the trendUsed the direction of the trend to identify
profitable opportunities.Buy low, sell highDecision-making process goes against human
emotion
Intraday profitability of Contrarian Strategy
Future Possible ResearchApart from NYSE and NASDAQ, which other stock
exchanges would be suitable for this strategy and why?To consider the use of volume as an additional filter?Is it worth it?
Transaction costsCost of monitoring stocks
In 1963-67, significant rebound of 1.87% expected on 1st 3 days.
1987-1991, rebound of 0.06%-Implication that overreaction is a sign of market inefficiency. Future?
Risks involved-dead cat bounce
ConclusionSignificant overreaction on NYSE and NASDAQ.
Stability analysis confirms findings.Call to attention “intraday reversal puzzle” due to
behavioral tradingDifferent behavior of bid-ask spread on NYSE and
NASDAQ due to different market mechanismsVolatility , volume and bid-ask spread increase
sharply at the event and stay significantly high long after price adjustment. Post-event decay of excess volatility well-described by power-law.
Intraday contrarian trading strategies are profitable in the event of extreme price changes.
Exact profitability of such strategy should be studied further.
THE END