Market frictions and stock return dynamics

Abstract

PurposeThis paper seeks to test the hypothesis that stock returns in the Athens Stock Exchange (ASE) adjust asymmetrically to past information due to differential adjustment costs.Design/methodology/approachThe methodological approach is based on the asymmetric price adjustment model suggested by Koutmos. The model is estimated using daily sector stock return data for the ASE over the period 2 January 1992‐1 March 1999.FindingsThe empirical evidence suggests that prices respond asymmetrically to past information. Specifically, positive past returns are more persistent than negative past returns of an equal magnitude. This behavior is consistent with an asymmetric partial adjustment price model where news suggesting overpricing (negative returns) are incorporated faster into current market prices than news suggesting underpricing (positive returns).Research limitations/implicationsThis paper does not investigate the possibility that the asymmetric price adjustment is related to conditional heteroscedasticity in stock return. Further research in this area should prove very useful.Practical implicationsThe findings in this paper have important theoretical and practical implications. On the theoretical level the findings suggest that violations of the efficient markets hypothesis could be due to market frictions and costly adjustments. On the practical level, the asymmetric adjustment process could improve trading profits, especially those based on momentum strategies.Originality/valueThis paper presents new findings on the stock price dynamics of the ASE. These findings should be of interest to researchers, regulators and market participants.