Stock Price Dynamics Surrounding Company-Specific Shocks

In this study, I analyze the correlation between stock returns before and after major price shocks. I hypothesize that if a large price move for a given stock takes place after a short period when the stock’s price moves in the same direction, then it may indicate that the fundamentals of the company-specific shock are more completely incorporated in the stock price, significantly increasing the probability of subsequent post-event price reversal. In order to test the study’s hypothesis, I employ the price data for all the stocks that made up the S&P 500 Index during the period from 1993 to 2019, and define significant price moves according to a number of alternative proxies referring to both raw and abnormal stock returns. I find that both large price increases and decreases are followed by significant one to three month price reversals (drifts) if they are preceded by the same- (opposite-) sign short-term cumulative abnormal returns. The effect remains significant after accounting for additional relevant company-specific (size, Market Model beta, historical volatility) and event-specific (stock’s return and trading volume on the event day) factors.