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