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Regular version of the site

Book chapter

The Underreaction and Overreaction in Asset Markets with Insider Trading

Meshalkina A., Gelman S. V.

In this paper we will lean on the behavioral explanation of return dynamics. The most popular behavioral origin of autocorrelation is gradual information diffusion between equity securities [Badrinath et al., 1995] and different groups of investors [Hong, Stein, 1999]. The first point out, that some piece of information is instantaneously considered to be price-relevant for a certain industry or individual company, but after a while the investors realize, that the information revealed has an effect on valuation of further assets, what induces the prices of these further stocks to follow and thus generate autocorrelation of index returns. The latter argue, that investors perceive different bits of news (even on the same company) and gradually exchange the information they got, until each of them can get together a whole picture from the different parts, similar to children putting a puzzle together. Since each investor gets the same bit of information from a previous investor, he acts on it in the same way (assuming he draws the same conclusions) with a lag, thus inducing serial correlation on single equity and index returns as well.