Title
Behavioral Biases and Stock Market Reactions: A Study of Pakistani Market.
Abstract
This study is an effort to answer the questions which traditional finance theories have failed to answer. Stock markets are run by human decisions which are the life blood for Behavioral Finance. The study also identifies the path through which behavioral biases affect the market where the investors over or under-react to upcoming news, leading to excess volatility and turnover patterns. Two heuristic driven biases from Behavioral Finance Micro that is, Self-attribution and Overconfidence and Anchoring, and two biases from Behavioral Finance Macro that is Herding and Disposition Effect has been selected for the purpose of study. Analyzing the daily return data for KSE 100 index for period of January 2000 to December 2014, it has been found that Pakistani investor is prone to overconfidence while making an investment decision giving more weightage to their own capabilities. When a 24-Week high was used as an anchor, investors showed underreaction to the sporadic news. On the contrary, when a historical high was used as an anchor, it leads to overreaction for prolonged news. Extreme market situation when defined at 5%, herding was found in down market situation, only implying that at times of low market returns investors tend to follow market trend. However, at extreme market defined at 10%, herding is significantly found in both up and down market conditions. Disposition effect is also found to be present in investors making them prone to realize paper gains as soon as possible. Existence of all the selected heuristic and behavioral biases makes the market highly vulnerable to irrational reactions. Using the methodology implied by Thaler (1975) tendency of overreaction has been found in KSE-100 index where ACARL is always greater than ACARW showing losers in one period outperformed in other testing period due to overreaction of investors. Examination of the contribution of market overreaction to the excess volatility in market has revealed that market over reaction has a significant effect over the excess volatility and thus, it can easily be predicted by assessing market behavior. Also trading volume/turnover driven by irrational behaviors and heuristics contribute to the excess volatility but in negative manner due to the momentum effect embedded in trading patterns.