INVESTOR SENTIMENT, OVERREACTION AND UNDERREACTION IN STOCK

Summary. The paper takes a theoretical approach in explaining how market sentiment affects investors’ overreaction and underreaction to information events. Notwithstanding a high scholarly interest in overreaction and underreaction phenomena that are widely explored in rational framed (David, 1997, Veronesi, 1999, Docking and Koch, 2005) and behaviorally framed settings (Barberis et al., 1998, Daniel, et al., 1998, Hong and Stein, 1999), the question how market sentiment affects investors ’ responses to information events remains largely unexplored. Resent research focuses on asymmetric investors ’ reactions to good and bad news that are dependent on the economic conditions. The majority of studies explore investors ’ overreaction and underreaction mostly in macro news context, but empirical findings are contradicting across financial markets. A few studies explore investors’ overreaction and underreaction to firm-specific news under the varying market sentiment. Therefore, the paper aims to explore the existing literature on market sentiment, investor overreaction and underreaction, theorizing sentiment effect of on investors ’ propensity to overreact and underreact to information events. The paper identifies limited scholarly attention to market sentiment as a source of investors ’ overreaction and underreaction and calls for further research that would test sentiment-driven investors ’ tendency to overreact and underreact to information events empirically. The paper contributes to a current body of research by proposing a relatively new research direction for testing overreaction and underreaction. It suggests that excessive market optimism (or pessimism) is transmitted through social interaction and affects investors ’ trading decisions reflected in stock price movements and trading volume. The paper provides some useful insights for innovation driven financial intermediaries. The deep understanding of financial market dynamics, its anomalies and the interaction of several economic quantities will ensure the fast adjustment of financial products and investment strategies to the market under varying market conditions