Evidence Against Emh

Over-reaction and Under-reaction

The efficient markets hypothesis implies that investors react quickly and in an unbiased

manner to new information. In two widely publicized studies, DeBondt and Thaler

present contradictory evidence.17 They find that stocks with low long-term past returns

tend to have higher future returns and vice versa - stocks with high long-term past returns

tend to have lower future returns (long-term reversals).

These findings received significant publicity in the popular press, which ran numerous

headlines touting the benefits of these so-called contrarian strategies.18 The results

appear to be inconsistent with the EMH. However, they have not survived the test of

time. Although the issues are complex, recent research indicates that the findings might

be the result of methodological problems arising from the measurement of risk.19 Once

risk is measured correctly, the findings tend to disappear.

One of the most enduring anomalies documented in the finance literature is the empirical

observation that stock prices appear to respond to earnings for about a year after they are

announced. Prices of companies experiencing positive earnings surprises tend to drift

upward, while prices of stocks experiencing negative earnings surprises tend to drift

downward. This "post-earnings-announcement drift" was first noted by Ball and Brown

in 1968 and has since been replicated by numerous studies over different time periods

17 W. DeBondt and R. Thaler, "Does the Stock Market Overreact," Journal of Finance (July, 1985).

18 For example, see B. Donelly, "Investors' Overreactions May Yield Opportunities in the Stock Market," Wall Street

Journal (January 7, 1988).

19 See E. F.Fama.and K. French, "Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance 51:55-

84 (March, 1996).

10.Efficient Markets Hypothesis/Clarke 19

and in different countries.20 After more than thirty years of research, this anomaly has

yet to be explained.

Another study