Overreaction hypothesis: Evidence from Istanbul Stock Exchange

Master ThesisOverreaction Hypothesis and Evidence from Istanbul Stock ExchangeFatma Dilvin TAŞKINDokuz Eylül UniversityInstitute of Social SciencesDepartment of ManagementMaster of FinanceThe aim of this thesis is to analyze the Overreaction Hypothesis, which isa famous behavioral finance approach that has challenged the Efficient MarketHypothesis. The overreaction hypothesis states that extreme movements in stockprices will be followed by subsequent movements in opposite direction. Pastlosers significantly outperform past winners, which is a violation of the weakform efficiency.In this thesis, the period between January 1992 and December 2005 isanalyzed in order to examine the evidence of overreaction and the success ofcontrarian strategies in Istanbul Stock Exchange (ISE). Using a modifiedversion of DeBondt ad Thaler?s methodology winner, loser and arbitrageportfolios are formed for one- two- and three- year portfolio formation and testperiods. The data is overlapped by shifting the periods for three months inorder to increase the number of observations and the statistical significance.The results show that for all formation and test periods, there issubstantial price correction in the market, which supports the overreactionhypothesis. The evidence may indicate that ISE is not weak form efficient. Theuse of contrarian strategies will provide substantial profits in the arbitrageportfolio both for one-year two-year and three-year portfolio formation and testperiods. Except for the three-year analysis, the absolute values of returns ofwinner portfolios are higher than the loser portfolios, which is in contrast withDeBondt and Thaler?s (1985) findings.Keywords: 1) Overreaction Hypothesis, 2) Efficient Market Hypothesis,3) Contrarian Strategies, 4) Market Anomalies, 5) ISE