A Study of Stock Price Behavior in Taiwan via Residual Income Valuation Theory and Structural Identification

[[abstract]]This study adopts the methodology introduced by Lee (2006) to analyze stock prices in response to information shocks in six of Taiwan's stock market sectors and present market anomalies utilizing behavioral finance theory. Using the Residual Income Model (RIM) of equity valuation, we specified our empirical model to identify structural fundamental and nonfundamental shocks from reduced-form tangible and intangible news, and we obtained three major results. First, fundamental shock is primarily induced by tangible news and nonfundamental shock by intangible news, suggesting that tangible-oriented RIM can capture the information content of stock prices. Second, impulse response analyses show that investors generally underreact to fundamental shocks and consistently overreact to nonfundamental shocks in the short-run. This finding is compatible with the overconfidence theory of Daniel et al. (1998) in behavioral finance literature. Third, information diffusion efficiency in a market appears to depend on the value relevance quality of its tangible information. This is based on our finding that when tangible information constitutes a higher share of a market's fundamental shock, its price converges faster to the long-run equilibrium associated with the shock