Short-Run Overreaction, Stock Prices and Investors’ Irrationality in the Kuala Lumpur Stock Exchange

Abstract

This paper argues that investors are not always rational decision makers as assumed in most finance theories. As humans, investors are said to demonstrate biases in their judgement and decision making. Relying on intuition and ruleof- thumb, being optimistic and overconfident, and having the tendency to follow others are among the attributes which could prevent humans from being rational investment decision makers. Besides, being ill-informed due partly to institutional deficiencies may also contribute to their irrationality. This paper undertakes a study on short-run behavior of the Kuala Lumpur Stock Exchange (KLSE) prices, and documents the existence of short-run price overreaction in the January-December 1997 period. There are performance reversals in the portfolios of winners and losers in the ranking and test period weeks. We argue that investors’ irrationality may have played an important part in explaining the results. This study shows that in explaining behavior of share returns, the psychology of human decision making should be taken into consideration.