Elsevier

Journal of Financial Economics

Volume 28, Issues 1–2, November–December 1990, Pages 67-93
Journal of Financial Economics

Price reversals: Bid-ask errors or market overreaction?

https://doi.org/10.1016/0304-405X(90)90048-5Get rights and content

Abstract

We show that bid-ask errors in transaction prices are the predominant source of apparent price reversals in the short run for NASDAQ firms. Once we extract measurement errors in prices caused by the bid-ask spread, we find little evidence of market overreaction. On the contrary, we find that security returns are positively, and not negatively, autocorrelated. We also show that bid-ask errors lead to substantial spurious volatility in transaction returns; about half of measured daily return variances can be induced by the bid-ask effect.

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      Since there are no stocks in our sample (and only commodities), this explanation also does not seem to hold. Conrad and Kaul (1993) and Kaul and Nimalendran (1990) attempt to demonstrate that the long-run reversal profits may stem from errors in prices from non-synchronous trading and bid-ask spreads. Since our data does not come from actively traded markets, microstructure issues do not play an important role; therefore, our study also hardly supports this view.

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    We appreciate the comments and suggestions made by Clifford Ball, Victor Bernard, K.C. Chan, Jennifer Conrad, Tom George, Charles Jones, Andrew Karolyi, participants in finance seminars at Ohio State University and the University of Michigan, and especially Jerold Warner (the editor) and Eugene Fama (the referee). We also thank Amy McDonald for preparing the manuscript. Partial funding for this project was provided by the School of Business Administration, University of Michigan.

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