Does the Hong Kong Stock Market Overreact?

This study examines whether the Hong Kong stock market overreacts. By using monthly return data of all the common stocks listed on the Hong Kong Stock Exchange from January 1980 to December 1995, it examines the profitability of a contrarian strategy of buying prior losers and selling prior winners. The evidence shows that prior losers outperform prior winners by up to 68.59% in the subsequent five-year test period. This finding can be interpreted as investors' tendency to react over-optimistically to positive information and over-pessimistically to negative information, thus causing stock prices to take temporary swing away from their intrinsic values and then reverse back subsequently. Our result is consistent with that documented by Debondt and Thaler (1985) for the U.S. market. This study also investigates whether seasonality accounts for the abnormal return but finds that the overreaction effect is not caused by the well-known January effect. Further tests are conducted to investigate whether changes in betas of the winners and losers account for the abnormal return. The evidence shows that such changes are also minor, which cannot explain the price reversal phenomenon.