Short-Term Price Overreaction: Identifi Cation, Testing, Exploitation

1423

Discussion Papers

Deutsches Institut für Wirtschaftsforschung

2014

Short-Term Price Overreaction: Identification, Testing, Exploitation

Guglielmo Maria Caporale, Luis Gil-Alana and Alex Plastun

Electronic copy available at: http://ssrn.com/abstract=2526817

Opinions expressed in this paper are those of the author(s) and do not necessarily reflect views of the institute.

IMPRESSUM © DIW Berlin, 2014 DIW Berlin German Institute for Economic Research Mohrenstr. 58 10117 Berlin Tel. +49 (30) 897 89-0 Fax +49 (30) 897 89-200 http://www.diw.de ISSN electronic edition 1619-4535 Papers can be downloaded free of charge from the DIW Berlin website: http://www.diw.de/discussionpapers Discussion Papers of DIW Berlin are indexed in RePEc and SSRN: http://ideas.repec.org/s/diw/diwwpp.html http://www.ssrn.com/link/DIW-Berlin-German-Inst-Econ-Res.html

Electronic copy available at: http://ssrn.com/abstract=2526817

Short-Term Price Overreactions: Identification, Testing, Exploitation

Brunel University, London, CESifo and DIW Berlin

Guglielmo Maria Caporale* Luis Gil-Alana Alex Plastun

October 2014

University of Navarra

Ukrainian Academy of Banking

Abstract This paper examines short-term price reactions after one-day abnormal price changes and whether they create exploitable profit opportunities in various financial markets. A t-test confirms the presence of overreactions and also suggests that there is an “inertia anomaly”, i.e. after an overreaction day prices tend to move in the same direction for some time. A trading robot approach is then used to test two trading strategies aimed at exploiting the detected anomalies to make abnormal profits. The results suggest that a strategy based on counter-movements after overreactions does not generate profits in the FOREX and the commodity markets, but it is profitable in the case of the US stock market. By contrast, a strategy exploiting the “inertia anomaly” produces profits in the case of...