Does the Overreaction Hypothesis Stand the Test of Time Across Comparable Developed Markets: A Tale of Two Crises

This research examines the enduring validity of the 1985 Overreaction Hypothesis proposed by DeBondt and Thaler across comparable developed markets, utilizing monthly stock return data from CRSP and Compustat. Our findings reveal compelling evidence in support of the continued relevance of the overreaction hypothesis. Intriguingly, we observe a sustained behavioral pattern among stocks, persisting for up to two years after portfolio formation. In contrast to prior research, we observe a protracted time frame for the hypothesized role reversal between 'Winners' and 'Losers' during the selected sample period (2000 – 2020). Notably, major economic crises such as the 2007-2009 financial crisis and the 2020 COVID-19 pandemic fail to deviate from the established overreaction trend. Additionally, our analysis indicates a reduced influence of January seasonality. Furthermore, variables such as firm size, leverage, and equity beta appear inadequate in explaining the occurrence of market event overreactions, thereby underscoring the non-Bayesian psychological dimension inherent in investor decision-making processes.