Explaining Apparent Stock Market Anomalies

Abstract

The article provides a discussion of the psychological and behavioral investor aspects responsible for the phenomenon of stock price momentum. Anchoring, herding, overconfidence, mental accounting, myopic loss aversion, regret aversion, prospect theory, over-reaction and under-reaction, representativeness, non-transitivity and question framing, hindsight bias and pride, barn-door closing, sensation seeking, and response to market consensus estimate are all examined to offer explanations for the abnormal superior performance of value stocks over growth stocks. The authors use empirical testing to demonstrate that enough overconfident investors and financial analysts anchor on past EPS growth rates and systematically over-extrapolate to over-estimate the EPS of growth stocks and under-estimate the EPS of value stocks. As stock value correction sets in over time, value stocks tend to outperform growth stocks. The firm size effect is also examined. Results indicate that large-cap investing works better with the growth style strategy and that small-cap investing works better with the value style strategy.