Equity Returns After Large Price Shocks: Global Evidence

Using a sample of stocks experiencing large price changes in 40 countries over 20 years, we investigate the association between investors’ traits that vary by national culture – overconfidence, conservatism, and risk tolerance – and proposed theoretical explanations for short-term equity returns following large price shocks. We find that, consistent with the uncertain information hypothesis, investors in cultures with lower levels of risk tolerance overreact more to negative and less to positive price shocks than investors in more risk-tolerant cultures. We fail to find evidence of overreaction in more individualistic (overconfident) cultures; or underreaction in less trusting (more conservative) cultures. Differences in formal institutions across countries, such as short-selling restrictions and insider trading laws, also help explain variation in returns after price shocks. We use an instrumental variable approach to demonstrate causation. Overall, our findings highlight the importance of both informal and formal institutions to understand investors’ reaction to unanticipated information.