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Do unobservable factors explain the disposition effect in emerging stock markets?

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  • Hisham Farag
  • Robert Cressy

Abstract

In a previous paper, we utilized panel data methods to explore both cross-sectional variations and time series effects within the post-event period for losers' stocks. Some of these effects are not observable, but ignoring them lays the estimation open to bias from concealed heterogeneity amongst firms and periods (Hsiao, 2004). In this article we re-examine our methodology to test whether past losers outperform past winners. Using daily data from the Egyptian stock market on a sample of 20 companies which experienced dramatic 1-day price change over the period 2005 to 2008, a two way Fixed Effects (FE) model reveals strong evidence of price reversal with period FE. Results support the disposition effect by selling winners short and buying losers. Firm size is negatively correlated with post-event Abnormal Returns (ARs) consistent with the argument that small firms have a greater tendency to price-reverse. However, temporary, unobservable time-specific phenomena common to all companies, together with permanent, unobservable company-specific factors are more important in explaining price reversals. We also find that, unobservable company-specific factors account for a much larger percentage of post-event variations in stock prices. These company effects are sufficiently large to suggest a profitable trading strategy.

Suggested Citation

  • Hisham Farag & Robert Cressy, 2010. "Do unobservable factors explain the disposition effect in emerging stock markets?," Applied Financial Economics, Taylor & Francis Journals, vol. 20(15), pages 1173-1183.
    • Handle: RePEc:taf:apfiec:v:20:y:2010:i:15:p:1173-1183
    DOI: 10.1080/09603101003781463
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    Cited by:

    1. Boubaker, Sabri & Farag, Hisham & Nguyen, Duc Khuong, 2015. "Short-term overreaction to specific events: Evidence from an emerging market," Research in International Business and Finance, Elsevier, vol. 35(C), pages 153-165.
    2. Farag, Hisham, 2015. "The influence of price limits on overreaction in emerging markets: Evidence from the Egyptian stock market," The Quarterly Review of Economics and Finance, Elsevier, vol. 58(C), pages 190-199.
    3. Hisham Farag, 2014. "Investor overreaction and unobservable portfolios: evidence from an emerging market," Applied Financial Economics, Taylor & Francis Journals, vol. 24(20), pages 1313-1322, October.

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