Short-term market reaction after extreme price changes of liquid stocks

1. Short-term market reaction after extreme price changes of liquid stocks

2. Introduction • price evolution of liquid stocks after large intraday price change • Significant reversal • Volatility and volume stay high • NYSE-widen bid-ask spread • NASDAQ-almost constant bid-ask spread

3. NYSE versus NASDAQ

4. Defining Large Price Changes • Absolute Filter • Intraday price change > 2-6% within 10-120 mins • Relative Filter • Price move exceeding 6-10 times the normal volatility during that time of the day • Omit first 5mins and last 60mins of trading

5. Calculation of Average • Calculate average minute volatility, trading volume and bid ask spread based on 60 pre-event trading days • Compare volatility, volume and spread with pre-event minuteaverage.

6. Beta • Measure of volatility of a portfolio in comparison to the market • Calculated using daily stock prices and index changes of the 60 pre event trading days • Beta may change after large price shocks • Post-event abnormal return calculated using beta computed using 60 post-event trading days

7. Results-Intraday Price Reaction • Significant reversal 10-60mins after event • Faster reversal for price increases • Price reversal is bigger for decreases after 30-60mins interval • Abnormal return = Raw return – (beta * index return) • AR and RR very close

8. Price Reversal

9. NYSE price evolution

10. NASDAQ price evolution

11. Stability of Price Reversal • Size 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 results • 10-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.

12. 60-min raw returns after intraday 60-min price drops exceeding 2-6% and 6-10 times average 60-min volatility

13. 60-min raw returns after intraday 10-120-min price changes exceeding 4% and 8 times the average 10-12-min volatility

14. Evolution of volatility and volume • Transaction 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.

15. Evolution of volatility and volume on NYSE and NASDAQ

16. Decay of Volatility on NASDAQ

17. Decay of Volume on NASDAQ

18. Evolution of bid-ask spread on NYSE and NASDAQ

19. 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.

20. Contrarian Trading Strategy • Strategy when an investor attempts to profit by going against the trend • Used the direction of the trend to identify profitable opportunities. • Buy low, sell high • Decision-making process goes against human emotion

21. Intraday profitability of Contrarian Strategy

22. Future Possible Research • Apart 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 costs • Cost 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

23. Conclusion • Significant overreaction on NYSE and NASDAQ. Stability analysis confirms findings. • Call to attention “intraday reversal puzzle” due to behavioral trading • Different behavior of bid-ask spread on NYSE and NASDAQ due to different market mechanisms • Volatility , 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.

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