Investor Confidence and Returns Following Large One-Day Price Changes

Abstract

I hypothesize that post-event price behavior following large one-day price shocks is related to pre-event price and firm fundamental characteristics, and that these characteristics proxy for investor confidence. Several behavioral theories suggest how investors form their expectations, and I suggest four investor confidence hypotheses based on these theories. In addition to documenting further evidence of investor overreaction, my findings indicate that investors respond differently to negative price shocks than to positive price shocks. In particular, large price decreases generally drive positive post-event abnormal returns, while large price increases do not drive positive or negative abnormal returns. However, my main finding is that this relationship is altered when pre-event return and firm characteristics are introduced. This suggests that certain pre-event characteristics influence investor confidence, which in turn influences buying and selling decisions and thereby drives post-event returns. However, investor confidence appears to be lessened by a price shock effect.