Over-Pessimism of Bank Stocks since the Great Recession of 2008

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Date

2020-05

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The Ohio State University

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Abstract

In September of 2008, the "Great Recession" began and wreaked havoc on the global financial system. This severe panic caused fear, volatility, and a rise in the perceived risk of securities. In this unique environment, banks were a deserved scapegoat of the recession and the future profitability of banks was in question. This research investigates whether this severely negative sentiment led to investors being over-pessimistic in their views regarding bank stocks. Did internal psychological biases play a role in investors' disdain towards bank stocks? If this hypothesized pessimistic behavior can be shown, this research can provide evidence that either investors are irrational actors who have routinely incorrect views towards future cash flow streams of securities or that human biases obscured the ability to see the opportunity for a recovery in these securities. For this work, earnings per share (EPS) announcements act as adjustments to the stock's intrinsic value as the market theoretically reacts accordingly, to either affirm past predictions or edit those previously false forecasts immediately after earnings are announced. In order to turn EPS metrics into earnings reactions, we measured the price reaction from the 3 day period before earnings announcements through the day after to gauge investor sentiment. From this, we were then able to find whether investors and analysts were over/under-optimistic or over/under- pessimistic towards a sample of 48 banks from 2008-2019. Through a detailed examination of earnings reactions and regression analyses, it can be determined that investors were significantly over-pessimistic towards financial stocks. For example, in Q2 2008, the sample had an average "positive surprise" of 11.34%, meaning that the stock prices increased 11.34% on average from the day before its earnings announcement to the day after's closing price, signifying that analysts and investors were too pessimistic before earnings revealed the new reality of bank conditions. This phenomenon is tested for many variables including testing over differing time periods, for banks of different sizes by market cap, among many other factors. Through these tests, we are able to determine that irrational behavior persisted in this time period, providing evidence towards incorrectly biased actors in the market, and thus evidence against the Efficient Markets Hypothesis (EMH).

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2nd Place 2020 Denman Business and Society

Keywords

Behavioral Finance, Financial Crisis Behavior, Earnings Reaction, Bank Stocks, 2008

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