How Do Markets React to Fundamental Shocks? An Experimental Analysis on Underreaction and Momentum

We perform a market experiment to investigate how average transaction prices react to the arrival of new information. Following a positive shock in fundamental value, prices underreact strongly; following negative shocks we find evidence of a much less pronounced underreaction. After the shock, prices in both situations slowly drift towards the new fundamental value, leading to a characteristic momentum pattern. Controlling for investors' individual disposition effects we form high- and low-disposition markets and prove both underreaction and momentum to be stronger in the high-disposition group. While evidence is mainly in favor of underreaction models like Grinblatt and Han (2005), we conclude based on our findings that positive and negative shocks are not two sides of the same coin and encourage future studies to disentangle the asymmetry between the two situations more carefully