| Abstract: | The author explores the effect of the availability heuristic on large daily stock price changes and on subsequent stock returns. He hypothesizes that if a major positive (negative) stock price move takes place on a day when the stock market index rises (falls), then its magnitude may be amplified by the availability of positive (negative) investment outcomes. In both cases, the availability heuristic may cause price overreaction to the initial company-specific shock, resulting in subsequent price reversal. In line with the hypothesis, the author documents that both positive and negative large price moves accompanied by the same-sign contemporaneous daily market returns are followed by significant reversals on the next 2 trading days and over 5- and 20-day intervals following the event, the magnitude of the reversals increasing over longer postevent windows, while large stock price changes taking place on the days when the market index moves in the opposite direction are followed by nonsignificant price drifts. The results remain robust after accounting for additional company (size, beta, historical volatility) and event-specific (stock's return and trading volume on the event day) factors, and are stronger for small and volatile stocks. |
