Humanomics

Overreaction and Underreaction Anomalies in the

Indonesian Stock Market: A Sectoral Analysis

Journal: International Journal of Ethics and Systems

Manuscript ID IJOES-12-2017-0235

Manuscript Type: Research Paper

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Market anomaly, Contrarian Strategy, Price reversal, Overreaction and

Keywords:
underreaction behaviour, Winner-Loser portfolio
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2 Overreaction and Underreaction Anomalies in the Indonesian Stock Market:
3 A Sectoral Analysis
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5 Abstract
6 Purpose: This study empirically investigates the investor’s overreaction and underreaction behaviours across the
7 sectoral stock indices in the Indonesian stock market.
8 Design/Methodology: Nine weekly sectoral stock indices, comprising agriculture, mining, basic industry and
9 chemicals, miscellaneous industry, consumer goods industry, property and real estate, infrastructure, utilities and
10 transportation, finance, and trade, service and investment for the period 2009-2012 were analysed using the paired
11 dependent sample t-test. To provide a more insightful empirical evidence, the presence of market anomaly of
12 investor’s overreaction and underreaction were examined on five observations with different vulnerable time.
13 Findings: The study documented that the overreaction anomaly was presence among the winner portfolios in the
14 entire sectoral indices. With the exception of the sectoral index of basic industry and chemicals on the loser
15 portfolio, the study documented the presence of underreaction anomaly among all other sectoral indices in
16 Indonesia. These findings implied that the investors might be able to gain significant profits investing their monies
17 in the sectoral stock market in Indonesia by implementing the contrarian strategy.
18 Originality/value - Originality in this paper lies in the dicussion of overreaction of investors in Indonesia where the
19 stock market in Indonesia has great potential, different characteristics and different problem from other regions.
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21 Keywords: Overreaction and underreaction behaviour, Market anomaly, Winner-Loser portfolio,
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22 Price reversal, Contrarian Strategy.

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1. Introduction
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26 Some investors behave irrationally that causes a price to deviate and form a predictable
27 pattern from time to time and even survive for certain periods (Malkiel, 2003). As an individual,
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28 investor behaves and acts differently in response to an information, is one of the factors
29 underlying the occurrence of deviations on the efficient market theory. This market anomaly of
30 investor’s overreaction and underreaction to the movement of stock prices contradicts the market
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efficiency hypothesis of Fama (1970). According to Reilly and Norton (2006), basically, the
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presence of overreaction and underreaction market anomalies were due to three reasons, namely:
34 (i) the imperfection of market structure when in reality perfect market conditions cannot be
35 found; (ii) the deviant behaviour or behavioural biases of investors in the market; and (iii) the
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36 inaccuracy of the theory of capital markets used as reference allows the occurrence of deviance
37 in assessing a capital market.
38 Studies on the overreaction and underreaction anomaly have been motivated to identify the
39 proper investment strategy in the capital market, thus guarantee the maximum returns earned by
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investors. Galariotis (2014) critically reviews the literature on the presence of overreaction
42 among investors and its contrarian and momentum trading strategies. The driving forces of
43 investment performance and the role of risk and asset pricing as well as behavioural human traits
44 were identified as the future issues need to be focused by investors when investing their monies
45 in the stock market. The presence of overreaction and underreaction anomaly have also been
46 empirically explored intensively both in the developed and emerging stock markets worldwide.
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In the advanced stock markets, the studies on the overreaction anomaly have been
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49 investigated by Abebe Assefa et al. (2014), Chung et al. (2015), and Piccoli et al. (2017) in the
50 US; Bessière and Elkemali (2014) in Europe; and Durand et al. (2013) in Australia. Abebe
51 Assefa et al. (2014) found the stock market overreaction for a sample of the large U.S firms, thus
52 the contrarian strategy was relevant to rebalancing investment portfolios into this market. The
53 existence of the overreaction anomaly in the U.S stock market during the 1973-2005 period was
54 specific to the earlier time period due to the inefficient incorporation of information into prices
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and largely attributable to an environment with high barriers to arbitrage. Additionally, Piccoli et
57 al. (2017) found the stocks in the US tend to overreact to both positive and negative events, but
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in a more pronounced way in the latter case over the 1926-2013 period. The overreaction
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3 anomaly was also presence in the European stock market over the 1997-2007 period when the
4 information has not yet been made public, but it disappears just after public release (Bessière and
5 Elkemali, 2014). Meanwhile, in the Australia, the personality traits have been found to be
6 associated with overconfidence and overreaction in her financial markets (Durand et al., 2013).
7 Studies on the overreaction anomaly have also focused on the emerging stock markets. For
8 example, the studies on overreaction anomaly have been conducted by Ansari and Khan (2012)
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and Maheshwari and Dhankar (2017) in India; Subadar Agathee (2012) in Mauritius; Boubaker
11 et al. (2015) in Egypt; and Zainudin and Hussin (2015) in the Shenzhen market. Adopting both
12 risk based and behavioural models, Ansari and Khan (2012) and Maheshwari and Dhankar.
13 (2017) find the presence of momentum profits in India during 1995-2006 and 1997-2013,
14 respectively. The presence of the momentum profits was also documented in Mauritius for the
15 2001-2009 periods (Subadar Agathee, 2012). Similarly, in the Egyptian stock market, Boubaker
16 et al. (2015) found the short-term overreaction, where the losers (bad news portfolios)
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significantly outperform winners (good news portfolios). Meanwhile, the underreaction and
19 overreaction anomaly was also documented among the investors in the Shenzhen market due to
20 their responses to information pricing errors (Zainudin and Hussin, 2015).
21 In the context of the Indonesian stock market, the studies on overreaction anomaly have
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22 been examined by Sumiyana (2009), Pasaribu (2011), Faisal and Majid (2016), and Andriansyah
23 (2017). Sumiyana (2009) examines the overreaction of the Indonesian LQ-45 stocks using
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intraday data in every 30-minute interval from January to December 2006 and found that the
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26 overreaction phenomena was commonly occurring in the opening and closing prices. In contrast,
27 using the DeBondt and Thaler (1985)’s approach, Pasaribu (2011) finds no symptom of
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28 overreaction anomaly at three-month, six-month, and annual periods of the LQ-45 stocks in
29 Indonesia during the 2003-2007 period. Similar to Sumiyana (2009), Faisal and Majid (2016)
30 and Andriansyah (2017) document market anomaly in the big-open Indonesian emerging market.
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The former study finds the existence of the calendar effects of the turn-of-month and the
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weekend effects during the period 2001 to 2014, while the latter study find the operating
34 performance of the firms was positively and negatively influenced by investment-to-price
35 sensitivity and information pricing errors, respectively.
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36 The existing studies on overreaction anomaly in Indonesia suffer major shortcomings, thus
37 they fail to presence reliable and comprehensive empirical evidences. Majority of studies found
38 the presence of overreaction anomaly (Sumiyana, 2009, Faisal and Majid, 2016, and
39 Andriansyah, 2017), while few studies found the absence of overreaction anomaly (Pasaribu,
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2011) in the Indonesian stock markets. These contradicting empirical evidences might lead to the
42 confusion among the inventors to implement proper investment strategies to gain maximum
43 profits in inventing their monies in the Indonesian stock market. These inconclusive findings
44 were simply due to the studies on the overreaction anomaly only investigated a specific market
45 such as LQ45 (Sumiyana, 2009 and Pasaribu, 2011) or the entire Indonesian market at the
46 aggregate level (Faisal and Majid, 2016 and Andriansyah, 2017).
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Motivated to provide a more insightful and comprehensive empirical finding on this issue,
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49 this study explores the overreaction and underreaction anomalies using all nine sectoral indices
50 of the stock markets. This is the main novelty of the present study, as to the best of our
51 knowledge, there has no study investigated both overreaction and underreaction anomalies at the
52 sectoral level in Indonesia. Additionally, comparing to the vast growing of the Indonesian
53 emerging market, the studies on this issue have been relatively meager. Maheshwari and
54 Dhankar (2017) affirmed that, one of the major limitations observed in the literature is that, most
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of the statistical overreaction and underreaction evidences are concentrated mainly for the highly
57 developed market and very few focused on the less developed market. Thus, this study would fill
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up this gap in the literature by offering more recent empirical overreaction evidence at the
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3 sectoral level in the big-open emerging market of Indonesia. Specifically, this study empirically
4 re-explore the presence of overreaction and underreaction anomalies in the all nine sectoral stock
5 indices (i.e., agriculture, mining, basic industry and chemicals, miscellaneous industry, consumer
6 goods industry, property and real estate, infrastructure, utilities and transportation, finance, and
7 trade, service and investment) in Indonesia during the 2009-2012 period.
8 The findings of this study are hoped to shed some lights for the investors to respond to
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information properly and instantaneously, thus implement a more profitable investment strategy.
11 Further, the evidence of contrarian profits on the Indonesian market would be of more interest to
12 domestic and foreign investors as it leads to gain higher abnormal profits. Additionally, the
13 empirical evidences on the overreaction and underreaction anomalies in the Indonesian market
14 would enrich the existing literature on the behavioural finance, thus offer more insight into the
15 development management of global financial markets.
16 The rest of this study is written in the following subsequence. Section 2 reviews the latest
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and relevant of the overreaction and underreaction anomalies literature and Section 3 provides
19 and highlights the data and empirical model. The discussion of the empirical findings and their
20 implications are provided in Section 4. Finally, Section 5 provides concluding remarks of the
21 findings and suggestions for future researchers.
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22 2. Literature Review
23 Overreaction and underreaction hypotheses were originated from the findings made by a
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psychologist from America, Kahneman and Tversky (1982) from experimental studies in
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26 psychology, where research was linked to the individual heuristic or bias in assessing the
27 uncertainty conditions. They have successfully integrated insights from psychological research
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28 into economic science suggesting that in the short term, people tend to think of the advantages
29 and disadvantages which tend to fear of loss were greater. This argument was proven by the
30 experimental studies done by them. Overreaction and underreaction hypotheses as proposed by
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De Bondt and Thaler (1985) stated that investors tended to overreact and underreact to new
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information and extraordinary phenomena. Rooted in the psychology of investors, overreaction
34 and underreaction hypotheses state that investors are experiencing cognitive biases that affect
35 their trading activities (Ali et al., 2011).When information comes, the investors overestimate or
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36 underestimate the impact of the information that has been spread, and thus prices tend to
37 overshoot or undershoot. This often happens when there is a dramatic event or important
38 information received by investors (De Bondt and Thaler, 1985).
39 The impacts of the investors’ misjudgment cause stock that contain good information tend
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to be over- or underpriced than it should be. Similarly, the stock price is associated with bad
42 (good) information tends to be underpriced (overpriced) than it should be. Furthermore, when
43 investors realize the truth of the news, they revise their beliefs and trading to correct the mistakes
44 in judgment. When investors revise their trading, there would be a price reversal on related
45 stocks. The presence of the reversal price means that the occurrence of overreaction and
46 underreaction in the market.
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The overreaction and underreaction hypotheses are the cause of the winner-loser anomaly,
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49 that is, shares that initially (formation period) obtain a positive return rate (winner) or negative
50 (loser) will experience the price reversal in the next period (subsequent test period). However,
51 the price reversal experienced only by the winner-loser portfolio is not sufficient to indicate the
52 existence of overreaction and underreaction. As specified in the overreaction and underreaction
53 hypothesis of De Bondt and by Thaler (1985), it indicated that overreaction (underreaction)
54 occurs when the winner portfolio on formation period is at decreased (increased) prices in the
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testing period, while for the loser portfolio, the overreaction (underreaction) occurs when a price
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movement of the loser portfolio is at increased (decreased) prices of the period of formation and
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3 testing period.
4 In connection with the winner-loser anomaly, the presence of the return reversal
5 experienced loser and winner stocks raises investment strategy, which is contrarian investment
6 strategy (Widiastuti and Jaryono, 2011). According to Putro (2012), the contrarian strategy was
7 the opposite strategy in a stock transaction, which meant that the investors tend to sell stocks
8 when markets rise (bullish) and buy stocks when the market’s decline (bearish).This strategy is
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used to anticipate the price reversal. The contrarian strategy can also be applied to the winner
11 and loser stocks, as it was first discovered by De Bondt and Thaler (1985) in the U.S market. In
12 their study, De Bondt and Thaler (1985) found that stocks which were originally loser stocks
13 tend to outperform stocks that have performed well (winner stocks) in the past. The contrarian
14 strategy can be applied to sell winner stocks and buy loser stocks in anticipation of price
15 reversal. The contrarian strategy is an alternative that can be used in a stock transaction, as
16 proposed by researchers who claim that this contrarian strategy can produce positive abnormal
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returns.
19 The phenomenon of overreaction anomaly has been intensively studied by researchers in
20 financial behaviour. De Bondt and Thaler (1985) found a pattern of predictability return in the
21 United States stock market for the long-term horizon of 3 to 5 years. The stocks with poor
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22 returns (loser stocks) in the past outperformed the stock performance which was relatively good
23 (winner stocks) in the test period. In other words, the winner and loser stock returns tend to
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experience a price reversal from time to time. This indicates that overreaction has occurred in the
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26 United States stock market at that time.

27 In addition to the long-term overreaction documented by De Bondt and Thaler (1985),
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28 there have been many studies documenting the existence of short-term overreaction. Jegadeesh
29 (1990) found significant results of the overreaction phenomenon for winner portfolio, which has
30 been established based on the return of the previous month. Likewise, Lehman (1990), who
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examined overreaction based on weekly returns, also found price reversal which was
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documented for the winner and loser portfolio in which the winner and loser portfolios were
34 selected based on the rate of return over the last week.
35 The studies on the overreaction and underreaction anomalies have been conducted more
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36 intensively in the developed stock markets than in the emerging stock markets worldwide.
37 Klößner et al. (2012) propose the model for stock prices consisting of a fundamental price
38 process and a news impact curve, which allows for overreaction, underreaction, or correct
39 response to changes in the fundamental value in the US and Germany stock markets. The
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empirical application of the model to different stock markets provides strong evidence for
42 intraday overreaction, particularly to the bad news.
43 Abebe Assefa et al. (2014) assess the performance of a contrarian investment strategy
44 focusing on frequently traded large-cap US stocks. The study documents the asymmetric
45 performance following portfolio formation. Although both, winners and losers portfolios, have
46 gained during holding periods, losers outperform winners at all times. The study concludes that
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the stock market overreaction was held for a sample of large firms, thus the contrarian strategy
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49 was relevant to rebalancing investment portfolios.
50 By utilizing the recent advancements in market microstructure research, Chung et al.
51 (2015) explore the existence of the overreaction anomaly in the US stock market during the
52 1973-2005 period. They find that the existence of the overreaction anomaly was specific to the
53 earlier time period and results from the inefficient incorporation of information into prices,
54 largely attributable to an environment with high barriers to arbitrage.
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The presence of overreaction in the European stock market was examined by Bessière and
57 Elkemali (2014). Specifically, they examine the link between uncertainty and analysts’ reaction
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to earnings announcements during the period 1997-2007, and their findings support the
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3 overconfidence hypothesis. Particularly, the overreaction in these markets was presence when
4 the information has not yet been made public and disappears just after public release. Studying
5 the overconfidence and overreaction in an experimental foreign exchange market among the
6 Australian investors, Durand et al. (2013) finds that those personality traits are associated with
7 overconfidence and overreaction in financial markets.
8 Piccoli et al. (2017) investigated the reaction of individual stock prices to extreme swings
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of the broader U.S market between 1926 and 2013. The study documented that stocks tend to
11 overreact to both positive and negative events, but in a more pronounced way in the latter case.
12 This behaviour is more intense when the market exhibits clustered extreme swings, indicating
13 that the overreaction and market volatility are related. The study concluded that the overreaction
14 is driven by the performance of loser stocks that revert more strongly, even as they exhibit a
15 lower market beta than winners. Alwathnani et al. (2017) assess the well-documented market
16 reaction to the announcements of earnings surprises is a manifestation of an investor
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underreaction or overreaction to extremely good or bad earnings news. Using the market reaction
19 in the three-day period surrounding the announcements of extreme earnings surprises, they found
20 the contradicting empirical evidence that investors underreact to earnings news. To the contrary,
21 the evidence suggests an initial investor overreaction to extreme earnings surprises signals.
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22 The overreaction was not only tested on stock returns, but also the existence of
23 overreaction was often associated with the trading volume. Conrad et al. (1994) provided some
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of the first evidences of the return reversal and trading volume for the stocks listed on the
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26 NASDAQ from 1983 to 1990. They found an evidence of a reversal in one week after portfolio
27 formation. Nevertheless, the author established a much stronger result for the volume of trade
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28 and its reversal. The sample was divided into high and low volume stocks based on changes in
29 the number of transactions during the previous week. Reversal reappeared only for high-volume
30 stocks. Surprisingly, the low volume stocks showed a negative profit for the loser portfolio,
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indicating the reversal prices of only for the high volume stocks.
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Studies on the overreaction anomaly have also focused on the emerging stock markets. For
34 example, Zainudin and Hussin (2015) investigate the noise trader risk, overreaction,
35 underreaction and information pricing errors in the Shenzhen market. Using the behavioural
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36 asset pricing model, capital assets pricing model, the information-adjusted noise model, and
37 model proposed by Ramiah and Davidson (2010), they find that the noise traders are dominantly
38 active of the time. Additionally, the Shenzhen market was under- and overreacts in response to
39 information pricing errors.
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Ansari and Khan (2012) explores the sources of momentum profit employing both risks
42 based and behavioral models and finds that strong presence of momentum profits in India during
43 1995-2006. Thus, in forming portfolios, selecting the stocks which have been winners in the last
44 three and six months can help investors and fund managers earn a substantial profit. Maheshwari
45 and Dhankar (2017) explores the profitability of momentum strategies in the Indian stock market
46 during the 1997-2013 period. The findings of the study were in favour of momentum
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profitability in the stock market. In contrast to the literature, he documents that the momentum
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49 profitability is driven by winning stocks, and hence buying past winning stocks generates higher
50 returns than shorting losing stocks in the market. He concludes that momentum effect in the
51 Indian stock market is not a manifestation of small size effect, value effect or illiquidity effect.
52 Subadar Agathee (2012) assesses the presence of the momentum effect on the Stock
53 Exchange of Mauritius for the 2001-2009 period. The study finds the existence of the momentum
54 effects on the market. Boubaker et al. (2015) investigate the short-term overreaction to specific
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events and whether stock prices are predictable for 100 listed stocks in the Egyptian stock
57 exchange during the period 2003-2010. They found that the short-term overreaction in the EGX.
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losers significantly outperform the winner's portfolios, thus the investors can earn an abnormal
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3 return by selling the winners and buying losers. The tensions in the Middle East region such as
4 the terrorist attacks have negative and significant abnormal returns on event day followed by
5 price reversals on day one to day four after the event.
6 One of the earliest studies on overreaction anomaly in the 47 Malaysian stocks was
7 conducted by Arifin and Power (1996) using weekly data from 1990 to 1994. The study only
8 selected 10 stocks of the top and bottom for winner and loser portfolios. The findings of this
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study showed that the winner stocks produced negative returns during the week one to three, and
11 the loser stocks produced a positive return for the ten weeks. It indicates that there was a reversal
12 return, an indication for the presence of overreaction at that time.
13 Furthermore, Ali et al. (2011) investigated the overreaction in the Malaysian market from
14 January 2000 to October 2010 by using weekly stock indices and found that the winner
15 portfolios tend to have a negative return, whereas the loser portfolio has a positive return for
16 various holding periods from one week to 52 weeks. The study showed that overreaction on the
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winner portfolio was lower than overreaction on the loser portfolio. In addition to overreaction
19 testing on return stock, the study also investigated the relationship between overreaction and
20 various categories of trading volume. The trading volume in this study classified stocks into
21 high, medium and low stock volumes. In each category volume, the shares are again grouped
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22 into winner and loser stock portfolios. The results showed that overreaction tends to be more
23 dominant on the loser for all categories of trading volume. Overall, the evidence of trading
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volume is still very ambiguous, several studies have reported a positive relationship and others
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26 noted an inverse relationship between volume and a short-term return reversal.

27 In the context of Indonesia, Pasaribu (2011) explores the existence of overreaction
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28 anomaly effect among the LQ-45 in the Indonesian stock market during the 2003-2007 period.
29 By using De Bont-Thaler approach, the study documents that there was no symptom of
30 overreaction anomaly at the three-month, six-month, and annual period. Sumiyana (2009)
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examines the noise and overreaction of the LQ-45 stocks in the Indonesian Stock Exchange
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using intraday data in every 30-minute interval from January to December 2006. The study
34 found that noise and overreaction phenomena were commonly occurring in the opening and
35 closing prices, and the investors simultaneously corrected the noise and overreaction at the first
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36 30-minute interval on every trading day. Andriansyah (2017) investigates the real effects of
37 primary and secondary equity markets on the post-issue operating performance of initial public
38 offering (IPO) firms in the Indonesian stock market over the period of 1999-2013. The study
39 found that the firm operating performance was related to the firm’s motivation to go public. The
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operating performance was positively affected by investment-to-price sensitivity and negatively
42 affected by stock price informativeness. Faisal and Majid (2016) re-examines three well-known
43 calendar anomalies of stock returns, including the effects of month-of-year, the turn-of-month,
44 and the weekend in the Indonesian stock market during the period 2001 to 2014. Of the three
45 calendar effects re-examined, they find the existence of two calendar effects of the turn-of-month
46 and the weekend effects.
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49 3. Data and Methodology
50 A weekly closing price of the 94 companies across nine sectors in the Indonesian stock
51 market was examined in the study. The selection of these companies were mainly based on the
52 purposive sampling method with the following specific criteria, namely: (1) the sectoral
53 companies that their stocks have been traded consistently over the observation period of 2009-
54 2012; and (2) the portfolio of winners and loser are formed based on the Lihara et al. (2004) by
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stipulation of one third over the cumulative abnormal return in the portfolio formation period
57 (winner), and one third of bottom part of the cumulative abnormal return in the portfolio
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formation period (loser). All data of sectoral stock indices were obtained from the
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3 www.yahoo.finance.com over the period 2009 to 2012.
4 To investigate the behaviour of underreaction and overreaction on each sector, the study
5 then divides the period into the formation period of winner and loser portfolio and testing period
6 of the winner and loser portfolio. To capture the presence of underreaction and overreaction
7 anomalies entirely in the stock market, the study further divides observations into five formation
8 and testing periods. The existence of differences in the average abnormal return (AAR) across
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the sectoral stocks indicates the overreaction and underreaction of the winner and loser portfolios
11 during the formation and testing periods, respectively. The determination of formation and
12 testing periods for both winner and loser portfolios are shown in Table 1.
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14 Table 1. Observation, Formation and Testing Period
15 Observation Formation Period Testing Period Number of Weeks
16 1 Jan 2, 2009- Jun 26, 2009 Jul 30, 2009- Dec 25, 2009 26
17 2 Jan 2, 2009- Dec 25, 2009 Jan 1, 2010- Dec 24, 2010 52
18 3 Jan 1, 2010 – Jun 24, 2011 Jul 1, 2011- Dec 21, 2012 78
19 4 Jan 2, 2009 –Dec 24, 2010 Jan 7, 2011 –Dec 28, 2012 104
20 5 Jan 7, 2011 – Dec 30, 2011 Jan 6, 2012- Dec 28, 2012 52
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22 The determination of observation 1 with a period of 26 weeks for the formation and testing
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periods was based on the previous study by Octavio and Lantara (2014) who investigated the
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25 presence of overreaction behaviour in short-term periods in the Indonesian stock exchange.
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26 Referring to Ali et al. (2011) who investigated the investor overreaction behaviour in the
27 Malaysian stock market over a longer period of 52 weeks, thus the observations 2 and 5 of the
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28 study consists of a period of 52 weeks. Meanwhile, the determination of observation 3 with a

29 period of 78 weeks follows the study by Rahmawati dan Suryani (2005) who uses a relatively
30 long period of time to examine the existence of overreaction behaviour of investors in the
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Indonesian stock exchange. Finally, the determination of observation 4 with a period of 104
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33 weeks or 2 years was based on the study conducted by Putro (2012) who examined the contrarian
34 strategy on the Indonesian stock market.
35 To empirically examine the presence of the underreaction and overreaction anomalies in
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36 the Indonesian market, the expected and realised returns were calculated using the market-
37 adjusted model. These returns were calculated as the basis for measuring the abnormal return
38 (AR), average abnormal return (AAR), and cumulative abnormal return (CAR). The presence of
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those abnormal returns was considered as a parameter of underreaction and overreaction
41 phenomena within the stock market. According to Hartono (2009), the existence of abnormal
42 return was simply due to the difference between realised and expected returns.
43 Specifically, the test for underreaction and overreaction anomalies of the sectoral stocks in
44 Indonesia for both formation and testing periods on the five different observations is conducted
45 in the following sequences. Firstly, the study calculates the abnormal return of stock i on week t
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(ARit) for the formation period using the following formula:
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48 ARit = Rit - E(Rit) (1)
49 where Rit is the realised return of stock i on week t, and E(Rit) is the expected return of stock i on
50 week t. Secondly, the realised return was measured by the changes in the weekly stock prices.
51 Thirdly, the expected return was then measured by using the market-adjusted model, as follows:
52 E(Rit) = Rit - RMit (2)
53 where RMit is the market return which was measured by changes in the Jakarta composite
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indices. Fourthly, the study measures the cumulative abnormal return (CARit) using the
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56 following formula:
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1 t
2 CAR it = ∑ ARi t (3)
3 a =1
4 Finally, in this formation period, one-third of the highest abnormal return was categorised
5 as the winner portfolio, while one-third of the abnormal returns on the lowest part was
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categorized as the loser portfolio.
8 Similar to the formation period, the study also measures the weekly abnormal return of the
9 winner and loser portfolios in the 5-observation in the testing period. Additionally, in this testing
10 period, the study further measures the average abnormal return (AARt) using the following
11 formula:
12 k
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∑ AR
i =1
it
AARt = (4)
15 k
16 where AARt is the average abnormal return on t period, ARit is the abnormal return of stock i on
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period t, and k is a number of the winner and loser portfolios during formation period.
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Finally, the presence of underreaction and overreaction anomalies across sectoral stocks in
20 Indonesia are identified from a phenomenon of price reversal both for the winner and loser
21 portfolio based on the study by De Bondt and Thaler (1985). To test for the presence of the
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22 anomalies, the dependent paired-sample t-test was performed. The dependent sample t-test is the
23 most suitable test to be used in the study as it could examine the differences in average abnormal
24 returns of the winner and loser portfolios between the formation and testing periods. If the
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average abnormal returns of winner and loser portfolios during the formation period were
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27 different from the average abnormal returns of winner and loser portfolio during the testing
period, thus the underreaction and overreaction behaviour among the investors in the stock
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29 market was presence. Conversely, if there was no significant difference in the winner and loser
30 portfolios between the formation and testing periods, thus the underreaction or overreaction
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anomaly was not presence in the market.

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4. Findings and Discussion
35 This study empirically investigates the presence of investor’s overreaction and
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36 underreaction behaviour for winner and loser portfolio at the nine sectoral indices in the
37 Indonesia market. The overreaction (underreaction) behaviour could happen if price reversal
38 occurred at the winner (loser) portfolio (De Bondt and Thaler, 1985). Implicitly, overreaction
39 occurred when winner portfolio formed in the formation period experienced a price movement to
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the negative way in the testing period, which was also shown by the existence of a significant
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42
difference in the average abnormal return of winner portfolio between the formation period and
43 testing period. Conversely, underreaction of loser portfolio occurred when loser portfolio formed
44 in the formation period had a price movement to the positive way in its testing period, indicated
45 by the existence of a significant difference in the average abnormal return of loser portfolio
46 between the formation period and testing period. For testing the presences of overreaction and
47 underreaction anomalies, the paired dependent sample t-test was used. To capture the presence of
48
underreaction and overreaction anomalies entirely in the stock market, as explained earlier, the
49
50 study divided observations into five formation and testing periods, namely 26-week for the
51 observation 1, 52-week for the observations 2 and 5, 78-week for the observation 3, and 104 for
52 the observation 4.
53 Tables 2 and 3 provide the finding of the investor’s overreaction and underreaction
54 behaviour in the Indonesian sectoral indices, respectively.
55
56
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1
Table 2. The Differences in the Average Abnormal Returns between Formation and Testing
2
3 Periods of the Winner Portfolio across Sectoral Stock Indices in Indonesia
Agriculture
4
5 Obs. Formation Period Testing Period t-value Sig-value Decision Conclusion
6 1 0.024 -0.007 1.600 0.122 H0, accepted No Overreaction
2 0.009 -0.002 1.174 0.246 H0, accepted No Overreaction
7 3 0.012 0.000 1.725* 0.089 H0,rejected Overreaction
8 4 0.009 -0.003 1.886* 0.062 H0, rejected Overreaction
9 5 0.009 -0.001 1.437 0.157 H0, accepted No Overreaction
10 Mining
11 1 0.037 -0.009 2.578** 0.016 H0, rejected Overreaction
12 2 0.015 -0.003 1.623 0.111 H0, accepted No Overreaction
13 3 0.004 -0.007 2.043** 0.044 H0, rejected Overreaction
4 0.007 -0.008 2.869*** 0.005 H0, rejected Overreaction
14 5 0.015 0.0131 0.110 0.913 H0, accepted No Overreaction
15 Basic Industry and Chemicals
16 1 0.027 -0.005 2.669** 0.013 H0, rejected Overreaction
17 2 0.014 -0.001 1.741* 0.088 H0, rejected Overreaction
18 3 0.012 0.000 2.201** 0.031 H0, rejected Overreaction
19 4 0.009 -0.001 1.933* 0.056 H0, rejected Overreaction
20 5 0.009 -0.005 2.093** 0.041 H0, rejected Overreaction
21 Miscellaneous Industry
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22 1 0.010 0.009 0.072 0.943 H0, accepted No Overreaction

2 0.010 -0.003 1.198 0.237 H0, accepted No Overreaction
23 3 0.019 0.003 2.341** 0.022 H0, rejected Overreaction
24 4 0.016 0.002 1.969* 0.052 H0, rejected Overreaction
25 2.033**
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5 0.015 -0.001 0.047 H0, rejected Overreaction

26 Consumer Goods Industry
27 1 0.029 0.000 2.657** 0.014 H0, rejected Overreaction
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28 2 0.018 0.007 1.636 0.108 H0, accepted No Overreaction

29 3 0.008 0.005 0.673 0.503 H0, accepted No Overreaction
4 0.013 0.002 2.116** 0.037 H0, rejected Overreaction
30 5 0.013 0.006 0.968 0.338 H0, accepted No Overreaction
31
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Property and Real Estate

32 1 0.036 0.002 2.022* 0.054 H0, rejected Overreaction
33 2 0.019 0.001 2.061** 0.044 H0, rejected Overreaction
34 3 0.126 0.026 1.822* 0.072 H0, rejected Overreaction
35 4 0.012 0.001 1.968* 0.052 H0, rejected Overreaction
ics

36 5 0.017 0.002 2.083** 0.042 H0, rejected Overreaction

Infrastructure, Utilities, and Transportation
37
1 0.020 -0.004 1.795* 0.085 H0, rejected Overreaction
38 2 0.015 0.005 0.829 0.411 H0, accepted No Overreaction
39 3 0.007 -0.001 1.333 0.186 H0, accepted No Overreaction
40 4 0.011 0.002 1.443 0.152 H0, accepted No Overreaction
41 5 0.003 -0.000 0.531 0.598 H0, accepted No Overreaction
42 Finance
43 1 0.016 0.007 0.673 0.507 H0, accepted No Overreaction
2 0.013 0.006 0.723 0.473 H0, accepted No Overreaction
44
3 0.009 0.001 1.430 0.157 H0, rejected Overreaction
45 4 0.010 0.001 1.730* 0.087 H0, accepted No Overreaction
46 5 0.007 0.003 0.655 0.515 H0, accepted No Overreaction
47 Trade, Service, and Investment
48 1 0.025 -0.007 3.080 *0.005 H0, rejected Overreaction
49 2 0.012 0.004 1.278 0.207 H0, accepted No Overreaction
50 3 0.013 0.007 1.452 0.150 H0, accepted No Overreaction
4 0.011 0.005 1.549 0.125 H0, accepted No Overreaction
51 5 0.014 0.006 1.210 0.232 H0, accepted No Overreaction
52 Note: ***, **, and * indicate significance at the 1%, 5%, and 10% levels.
53
54
55 As observed from Table 2, the overreaction behaviour was presence in all nine sectoral
56 indices, i.e., agriculture, mining, basic industry and chemicals, miscellaneous industry, consumer
57
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goods industry, property and real estate, infrastructure, utilities and transportation, finance, and
2
3 trade, service and investment for the period 2009-2012. However, the existences of overreaction
4 across sectoral indices were documented differently among the five-observations. In a more
5 detailed, the differences in the average abnormal returns between formation and testing periods
6 of the winner portfolio across sectoral stock indices in Indonesia existed in the observations 3
7 and 4 for the agricultural sector; observations 1, 3, and 4 for the mining sector; all observations
8 for the basic industry and chemicals, and property and real estate sectors respectively;
9
10
observations 3, 4, and 5 for the miscellaneous industrial sector; observations 1 and 4 for the
11 consumer goods industrial sector; observation 1 for the infrastructure, utilities and transportation,
12 and trade, service and investment sectors respectively; and observation 3 for the financial
13 sectors. These empirical findings showed that the overreaction existed both in short- and long-
14 term period in the Indonesian stock market, implying the presence of the price reversal in the
15 market. The presence of anomalies in both agricultural and financial sectors in the Indonesia
16 market was similar to the finding by Yoga (2010).
17
18
Furthermore, Table 3 reports the presence of underreaction anomaly among the loser
19 portfolios across sectoral indices in Indonesia. With the exception of the basic industry and
20 chemicals sectoral indices, the study found significant differences in the average abnormal
21 returns between the formation and testing periods of the loser portfolios, indicating the presence
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22 of underreaction anomaly in the market. Specifically, the underreaction among the loser
23 portfolios existed in the observation 2 for the agricultural sector; observation 4 for the mining
24
and financial sectors respectively; observations 3, 4 and 5 for the miscellaneous industrial sector;
25
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26 observation 1 for the consumer goods industrial sector; observations 2 and 4 for the property and
27 real estate sector; observations 3 and 4 for the infrastructure, utilities and transportation sector;
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28 and observations 1, 3 and 4 for the trade, service and investment sectors. The underreaction was
29 less presence in the more established stock such as in the basic industry and chemicals sectoral
30 indices. This is simply due to the stability of the sector towards the changes both in internal and
31
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external factors.
32
33
Table 3. The Differences in the Average Abnormal Returns between Formation and Testing
34 Periods of the Loser Portfolio across Sectoral Stock Indices in Indonesia
35 Agriculture
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36 Obs. Formation Period Testing Period t-value Sig-value Decision Conclusion

37 1 -0.010 -0.004 -0.487 0.630 H0, accepted No Underreaction
38 2 -0.010 0.006 -1.927* 0.060 H0, rejected Underreaction
39 3 -0.007 -0.005 -0.499 0.620 H0, accepted No Underreaction
4 -0.007 -0.006 -0.204 0.838 H0, accepted No Underreaction
40 5 -0.011 -0.008 -0.306 0.761 H0, accepted No Underreaction
41 Mining
42 1 -0.008 -0.013 0.443 0.662 H0, accepted No Underreaction
43 2 -0.010 -0.008 -0.293 0.770 H0, accepted No Underreaction
44 3 -0.008 -0.003 -0.805 0.423 H0, accepted No Underreaction
45 4 -0.010 0.013 -2.228** 0.028 H0, rejected Underreaction
46 5 -0.010 -0.008 -0.293 0.770 H0, accepted No Underreaction
Basic Industry and Chemicals
47
1 -0.021 0.001 -1.483 0.150 H0, accepted No Underreaction
48 2 -0.011 0.003 -1.560 0.125 H0, accepted No Underreaction
49 3 -0.010 -0.002 -1.492 0.140 H0, accepted No Underreaction
50 4 -0.008 -0.002 -1.282 0.203 H0, accepted No Underreaction
51 5 -0.006 -0.004 -0.349 0.728 H0, accepted No Underreaction
52 Miscellaneous Industry
53 1 -0.021 0.000 -1.593 0.124 H0, accepted No Underreaction
2 -0.016 -0.003 -1.549 0.127 H0, accepted No Underreaction
54
3 -0.006 0.004 -1.830* 0.071 H0, rejected Underreaction
55 4 -0.011 0.005 -2.632*** 0.010 H0, rejected Underreaction
56 5 -0.006 0.012 -2.740*** 0.008 H0, rejected Underreaction
57
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1 Consumer Goods Industry

2 1 -0.016 0.004 -1.853* 0.076 H0, rejected Underreaction
3 2 -0.007 0.001 -1.167 0.249 H0, accepted No Underreaction
4 3 -0.002 0.003 -1.249 0.215 H0, accepted No Underreaction
5 4 -0.004 0.004 -1.529 0.129 H0, accepted No Underreaction
6 5 -0.003 0.006 -1.508 0.138 H0, accepted No Underreaction
Property and Real Estate
7
1 -0.017 -0.007 -0.723 0.476 H0, accepted No Underreaction
8 2 -0.013 -0.000 -1.694* 0.096 H0, rejected Underreaction
9 3 -0.003 0.004 -1.410 0.163 H0, accepted No Underreaction
10 4 -0.007 0.009 -3.404*** 0.001 H0, rejected Underreaction
11 5 -0.013 0.026 -0.580 0.564 H0, accepted No Underreaction
12 Infrastructure, Utilities, and Transportation
13 1 -0.014 -0.009 -0.512 0.613 H0, accepted No Underreaction
2 -0.012 -0.003 -1.344 0.185 H0, accepted No Underreaction
14
3 -0.009 0.003 -2.366** 0.021 H0, rejected Underreaction
15 4 -0.010 0.002 -2.682*** 0.009 H0, rejected Underreaction
16 5 -0.008 -0.001 -1.223 0.227 H0, accepted No Underreaction
17 Finance
18 1 -0.014 -0.005 -0.991 0.331 H0, accepted No Underreaction
19 2 -0.010 -0.002 -1.568 0.123 H0, accepted No Underreaction
20 3 -0.004 0.002 -1.455 0.150 H0, accepted No Underreaction
4 -0.007 0.002 -1.795* 0.077 H0, rejected Underreaction
21
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5 -0.007 -0.000 -1.106 0.274 H0, accepted No Underreaction
22 Trade, Service, and Investment
23 1 -0.021 0.000 -2.193** 0.038 H0, rejected Underreaction
24 2 -0.013 -0.007 -0.905 0.369 H0, accepted No Underreaction
25 3 -0.006 0.004 -2.212** 0.030 H0, rejected Underreaction
m

26 4 -0.011 0.008 -3.377*** 0.001 H0, rejected Underreaction

27 5 -0.005 0.002 -1.234 0.223 H0, accepted No Underreaction
Note: ***, **, and * indicate significance at the 1%, 5%, and 10% levels.
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28
29
30
31
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The above findings indicated that the underreaction existed both in short- and long-term
32
33 period in the Indonesian stock market, implying the presence of the price reversal in the market.
34 The existence of price reversal among the winner and loser portfolios further implied that the
35 investors have over- and under-reacted to the stock price movements due to new information and
ics

36 incredible events (De Bondt and Thaler (1985). Investor’s overreaction behaviour towards good
37 news predicted prices to increase greater than it should be (overpriced), meanwhile investor’s
38 underreaction to the bad news tended to predict prices to decrease slightly (underpriced). When
39
40
the investors aware of the truth of news, they would revise their predictions and trade to resolve
41 mistakes in their earlier assessments. These findings further indicated that the investors have
42 behaved irrationally due to informational cognitive biases, thus showing the Indonesian stock
43 market was inefficient during the period of study.
44 In this study, we found that the winner portfolio in the formation period tended to
45 experience price reversal in the testing period. The existence of price reversal in the testing
46
period indicates that overreaction investor, which was indicated in the formation period of
47
48 winner portfolio caused prices increased greater than it should be so that they could be more
49 superior to prices of other stocks. When investors realize about their misjudgment, they would
50 engage in the price reversal strategy. As for the loser portfolio, price reversal that occurred in the
51 testing period shows that investor underreaction in the formation period caused prices decreased
52 lower than it should be, thus their performance was inferior to the other stock prices. When
53 investors aware of their misjudgment, they would re-analyse their stock trading that causes the
54
price reversal.
55
56 Our findings on the presences of overreaction and underreaction in the Indonesian stock
57 market was very much in line with the previous studies in the stock markets of U.S (Abebe
58 11
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Assefa et al., 2014; Chung et al., 2015; Piccoli et al., 2017), Europe (Bessière and Elkemali,
2
3 2014), Australia (Durand, 2013), India (Ansari and Khan, 2012; Maheshwari and Dhakar, 2017),
4 Mauritius (Subadar Agathee, 2012), Egypt (Boubaker et al., 2015), and China (Zainudin and
5 Hussin, 2015). Similarly, these empirical findings also confirmed the earlier findings on the
6 presence of the anomaly in Indonesian stock market (Sumiyana, 2009; Octavio and Lantara,
7 2014; Faisal and Majid, 2016; Andriansyah, 2017).
8 These findings further suggest that the contrarian strategy was the most relevant to
9
10
rebalancing investment portfolios into this market. The investors could earn abnormal returns by
11 selling the winners and buying losers (Boubaker et al., 2015). The existence of the overreaction
12 and underreaction anomaly in the Indonesian stock market during was due to the inefficient
13 incorporation of information into prices and largely attributable to an environment with high
14 barriers to arbitrage.
15
16
17 5. Conclusions
18 This study empirically explored the investor’s overreaction and underreaction anomalies
19 across nine sectoral indices in Indonesia. Using weekly sectoral stock indices for the period
20
2009-2012, the presence of market anomaly of investor’s overreaction and underreaction were
21
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22 examined on five observations with different vulnerable time using the paired dependent sample
23 t-test. The study documented the presence of overreaction anomaly in the entire sectoral indices
24 in Indonesia. However, the underreaction anomaly was not presence only in the sectoral index of
25 the basic and chemical industry.
m

26 The existence of overreaction in the market revealed that the movement direction of
27 average abnormal return of the winner portfolio was decreasing from the formation period to the
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28
testing period. Meanwhile, the existence of underreaction showed the movement direction of
29
30 average abnormal return of the loser portfolio was rising from the formation period to the testing
31 period. These findings further implied the existence of price reversal by the winner and loser
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32 portfolios in the Indonesian sectoral stock markets. Thus, the contrarian strategies should be
33 considered as the best strategy for the investors to be adopted to minimise the risks for
34 diversifying their portfolios across sectoral indices in the Indonesian stock markets.
35 The findings of the study are based on the empirical frameworks outlined above. For a
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36
37
more reliable and robust findings, further studies should cover broader stock market worldwide,
38 including the recent emerging of the Islamic stock markets. Additionally, further studies should
39 utilize a more frequent and longer period of data so that their findings become more
40 generalizable for various stock markets with similar characteristics.
41
42
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