US and international stock reaction to common information

As an out of sample test of the behavioral models of Barberis, Shleifer, and Vishny (1998), Daniel, Hirshleifer, and Subrahmanyam (1998) and Hong and Stein (1999), we extend Kothari, Lewellen, and Warner (2006) and examine both US and international stock price reaction to common market-wide information. Using a regression approach, we examine two sets of US portfolios: size-sorted portfolios and book-to-market-ratio-sorted portfolios over the period 1941-2006 and international stock markets over the period 1975-2006. We find evidence of both under- and over-reaction but it is not systematic, nor is it as the behavioral models predict. We conclude that though investors may make mistakes, they do not do so consistently. Thus, we interpret our results are consistent with the efficient market hypothesis and with the more recent evolutionary model of Lo (2006).