Tehran Stock Exchange Underreaction Following Extreme Market Events

Abstract

Objective: The purpose of this study is to investigate the presence of under-reaction or over-reaction in Tehran Stock Exchange after extreme market events. Regarding the vast number of these events, finding how investors trade in these conditions is crucial for timely decision making and portfolio management. Regulations also can be wisely made to control investors. Methods: Using daily TEDPIX and daily prices of all stocks from 2009 – 2018, we identify extreme market events by comparing daily market returns with the 500- days moving Value at Risk (VaR) of returns. Winner and loser portfolios are formed in the second stage and Then, we investigate the presence or absence of under-reaction or over-reaction by comparing momentum and reversal strategies' excess return. Positive values of momentum strategy excess returns lead us to under-reaction and positive values of reversal strategy lead us to an over-reaction. Results: According to the results from the present study, from 67 extreme events in the research period, we have 30 positive and 37 negative extreme events. The momentum strategy yields a positive and significant excess return on average. Consequently, we find that stocks tend to under-react after both positive and negative events. But this behavior is more intense after negative events. Thus, the momentum strategy can make excess returns. Also, we didn't find the persistence of over-reaction within the study criteria. Conclusion: Short-term under-reaction in the Tehran Stock Exchange may be due to the daily price limit of this market. Disregarding of the cause, investors can make a profit by taking advantage of the opportunity in the days following an extreme event. In other words, investors that prefer a momentum strategy can have notable excess returns in the days following an extreme event.

Keywords

• value at risk
• underreaction
• overreaction
• extreme event