Short-Term Predictability of Stock Market Indexes following Large Drawdowns and Drawups

Vinicius Brandi (vinicius.brandi@gmail.com)

No 529, Working Papers Series from Central Bank of Brazil, Research Department

Abstract: The Efficient Market Hypothesis is one of the most popular subjects in the empirical finance literature. Previous studies in the stock markets, which are mostly based on fixed time price variations, do not provide conclusive findings, in which evidence of short-term predictability varies according to different samples and methodologies. In this work, we propose a novel approach and use drawdowns and drawups as trig-gers in order to investigate the existence of short-term abnormal returns in the stock markets. As these measures are not computed within a fixed time horizon, they are flexible enough to capture time-dependent subordinated processes that could be driving market under or overreaction. According to our results the Efficient Market Hypothesis is supported by the majority of estimates. Results also provide stronger support for underreation hypothesis than for overreaction, with the highest preva-lence of return continuations than reversals. Evidence for the Uncertain Information Hypothesis is present in some markets, mainly after events of lower magnitude.

Date: 2020-07
New Economics Papers: this item is included in nep-fmk
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