Overreaction following the Announcement of COVID-19 Lockdown;

Evidence from Pakistan Stock Exchange

By

Tawab Ahmed

July 2021

Thesis submitted to the Institute of Management Sciences, Peshawar,

In partial fulfillment of the requirements for the Degree of
BS-Accounting and Finance

Institute of Management Sciences Hayatabad

Peshawar, Pakistan
 Certificate of Approval
I certify that I have read the research “Overreaction following the Announcement of COVID-

19 Lockdown; Evidence from Pakistan Stock Exchange” by, and my opinion this work meets

the criteria for approving a thesis submitted in partial fulfillment of the requirements for the BS-

Accounting and Finance at the Institute of Management Sciences, Peshawar.

Supervisor Name: Muhammad Afraz Abdur Rahman

Designation: Lecturer

Signature: ___________________

Coordinator Research & Development Department

Name: Dr. Saleem Gul

Signature: _________________
 Declaration
I, Tawab Ahmed, hereby declare that the research thesis submitted to R&DD by me is my own original
work. I am aware of the fact that in case my work is found to be plagiarized or not genuine, R&DD has the
full authority to cancel my research work and I am liable to penal action.

Signature: _________________
 Abstract

In this study, we examine how the Pakistan stock exchange reacted to the sudden outburst of the
COVID-19 global pandemic specifically to the announcement of lockdown by regional and
central government. Reversals were observed both at the level of industry and at the level of
individual firms as a result of retail investor overreaction to the announcement of COVID-19
lockdown, for industries which had the most positive CAR in the event window were observed to
have had the strongest reversals, such as the pharmaceuticals and the textile spinning industry.
Thus, it can be inferred that the reversal phenomenon was mostly caused by stocks that had a
positive reaction to the announcement in the event period. Furthermore, it was observed that
stocks with lower level of institutional ownership reacted to the announcement more than the
stocks which had higher level of institutional ownership, thus the phenomenon was mainly
driven by retail investors.

Keywords: Cumulative abnormal returns (CAR), Overreaction, Reversals, COVID-19,

Pandemic, Lockdown, Pakistan Stock Exchange
 Acknowledgement
First, I dedicate my research to my mother, my grandmother & my fiancé who
have been a source of constant support and admiration. Secondly, I am very
thankful to my supervisor who was very kind, helpful and encouraging
throughout the research process. Lastly, I would also thank my batch mates
and colleagues who inspired me to be a better version of myself.
Table of Contents
CHAPTER 1 INTRODUCTION ............................................................................................................ 1
1.1 Problem Statement ........................................................................................................................ 3
1.2 Research Gap ................................................................................................................................ 3
1.3 Research Objectives ...................................................................................................................... 3
1.4 Research Hypothesis ..................................................................................................................... 3
CHAPTER 2 LITERATURE REVIEW ................................................................................................. 4
2.1 Conceptual Framework ............................................................................................................... 13
CHAPTER 3 METHODOLOGY.......................................................................................................... 16
3.1 Study design ................................................................................................................................ 16
3.2 Data Collection ........................................................................................................................... 17
3.3 Variables ..................................................................................................................................... 17
3.3.1 Dependent Variable.................................................................................................................... 17
3.3.2 Independent Variable ................................................................................................................. 18
3.3.3 Control Variables ....................................................................................................................... 18
3.4 Model of the Study...................................................................................................................... 19
CHAPTER 4 DATA ANALYSIS ......................................................................................................... 20
4.1 Descriptive statistics ................................................................................................................... 20
4.2 Correlation analysis .................................................................................................................... 21
4.3 Regression analysis ..................................................................................................................... 22
4.4 Reversals at firm level................................................................................................................. 22
4.5 Reversals at industry level .......................................................................................................... 24
CHAPTER 5 CONCLUSION ............................................................................................................... 27
5.1 Implications and recommendations ............................................................................................ 27
5.2 Limitations .................................................................................................................................. 28
References 29
Table of Tables
Table 1: Variable Summary ........................................................................................................................ 19
Table 2: Descriptive Statistics .................................................................................................................... 21
Table 3: Correlation Table .......................................................................................................................... 22
Table 4: Reversals at firm level .................................................................................................................. 23
Table 5: Reversals at Industry level ............................................................................................................ 25
Table of Figures
Figure 1: Shows that relationship between variables .................................................................................. 15
Figure 2: Event window for COVID-19 in Pakistan................................................................................... 17
Table of Equations
3.4.1 Equation for firm level analysis (1) ................................................................................................... 19
3.4.2 Equation for firm level analysis with INI (2) ..................................................................................... 19
3.4.3 Equation for Industry level analysis (3) ............................................................................................. 19
 CHAPTER 1 INTRODUCTION

The unexpected outburst of the infectious disease COVID-19 has flared up uncertainties regarding

many facets surrounding the outbreak (Baker, Bloom, Davis & Terry, 2020) which will eventually

have an effect on the global economy in the year 2020. Stock market being the integral part of a

country’s economy is also anticipated to have been affected (Huo & Qiu, 2020). Baker, Bloom,

Davis, Kost, Sammon and Viratyosin (2020) have shown that market volatility in United States

has regained its highest value in history.

Some studies (e.g., Huo & Qiu, 2020) have been conducted to gauge the impact of lock down

announcement on their respective markets, however its impact on the Pakistan Stock exchange

has not been researched. The study will be carried out to test the plausibility of Efficient Market

Hypothesis in extraordinary circumstances like the COVID-19 pandemic in the context investor

overreaction concept introduced by (Debont & Thaler, 1985).

Lehmann (1990) noted that Efficient Market Hypothesis has been a cornerstone for research in the

area of Financial Economics. However extant literature has shown inconsistencies in the renowned

idea of efficient markets, the statement that stock prices in efficient markets are representative of

all readily available information (Fama, 1970) has been under scrutiny for decades Bernstein

(1985) documented that stock markets are highly efficient in quickly incorporating recent

information that has its effects on stock prices in the short run while failing to represent longer

term information in prices in an efficient manner also Kahneman and Tversky (1982) exclaimed

that people tend to put more focus on current information while undermining and ignoring

distributional data. DeBondt and Thaler (1992) found reversals over (multiyear) horizons, while

studies conducted by Jegadeesh (1990) and Lehmann (1990) noted reversals over short horizons

of a month or less.

1
Lehmann (1990) concluded that there are two possible explanations to the short-lived effect of

reversals. First, that arbitrage opportunities are by nature short lived and that on average equity

markets are efficient over longer horizons such as one month. Second, that the tests used to observe

inconsistencies fail to detect them while considering a longer horizon, hence the need for further

evidence is paramount.

Huo and Qiu (2020) documented the existence of reversals at both the industry and firm’s level,

they found that industries and stock that possessed a positive cumulative abnormal return in the

observed event window, showed greater reversals. Conclusions included that overreaction in

Chinese stock market was generally driven by industries and stocks that reacted positively to the

announcement of lockdown, Also among the conclusion were that overreaction for stock with

lower institutional ownership was stronger which in turn means that retail investors have reacted

more dramatically to the COVID-19 outbreak.

Stock market in Pakistan was facing unprecedented levels of uncertainty surrounding the topic of

government intervention and lockdown across the nation, the research will be carried out to find

out whether the overreaction can be observed in the event window following the lock down

announcement. The study will try to observe the phenomenon on industry as well as on firms’

level considering short-run event windows, the lack of short-run considerations in extant literature

remains to be a gap. The study aims to determine the consequences of measures like lockdown on

the economic health of the country, which will eventually be of help while policy making for future

uncertain events.

2
1.1 Problem Statement

COVID-19 global pandemic has been a source of immense uncertainty regarding the future of

global economy, the extent of the effect of such events needs to be assessed in order to better

design and implement preventative measure where they are relevant. Pakistan being a country in

financial distress needs better understanding of such events because it can severely affect the

already ailing economy trying to push its way into sustainability.

1.2 Research Gap

The study tries to examine the effect of COVID-19 on the Pakistan stock exchange empirically.

There has been no study performed which tests the overreaction phenomenon during COVID-19

in Pakistan at present, according to the best of researcher’s knowledge. The study employs the

event study methodology to gauge the impact of overreaction caused be uncertainty surrounding

the pandemic.

1.3 Research Objectives

The study will try to achieve the following objectives

RO1: To find out if the Stock market overreacted to the announcement of COVID-19 Lockdown

on the level of industry

RO2: To find out if the Stock market overreacted to the announcement of COVID-19 Lockdown

on the level of individual stocks

1.4 Research Hypothesis

Following DeBondt and Thaler (1985), study proposes the following hypothesis:

H1: Abnormal appreciation in stock prices during the event window will be followed by a price

reversal in the opposite direction

3
 CHAPTER 2 LITERATURE REVIEW

The outbreak of COVID-19 was abrupt and unforeseen, it has flared up uncertainties across the

globe regarding the overall global economic health (Baker, Bloom, Davis & Terry, 2020).

Numerous studies have been published in a rather short time frame to study the effects of COVID-

19 on the economy. For instance, the instant impact of the COVID-19 pandemic on individual

firms was studied by Hassan, Hollander, van Lent and Tahoun (2020) while Jorda, Singh & Taylor

(2020) studied the economic consequences of COVID-19 in the Long-run. Other than that, Baker,

Farrokhnia, Meyer, Pagel and Yannelis (2020) studied consumer behaviour and concluded that

behaviour of household consumers has changed due to the COVID-19 outbreak. Moreover,

governmental policies concerning COVID-19 vary from across countries, which have been subject

to scrutiny. Krueger, Uhlig and Xie (2020) in their study examine government mediation and its

efficacy. Baker, Bloom, Davis, Kost, Sammon and Viratyosin (2020) noted that Equity-market

volatility in the United States has reached a historic high. The study, in support of the extant

literature examines the response of the Pakistan equity market to COVID-19, after the

announcement of the lockdown by the government.

The concept of stock market overreaction and price reversals goes back to the paper published by

DeBondt and Thaler (1985) and still a topic of debate amongst researchers. Extant literature

explains reversals in two ways, one of the ways is to attribute reversals to investor overreacting

behaviour and the other is to attribute the phenomenon to liquidity provision. Study will examine

the equity market reaction to announcement of lockdown, and thus, in this case the literature on

overreaction is relevant.

DeBondt and Thaler (1985) proposed that stocks prices tend to reverse when considering longer

holding period horizons, they hypothesized that this tendency can be accredited to investor

4
behaviour because investors tend to overvalue recent performance, while undervaluing long term

information while making decisions. While testing their hypothesis, they didn’t make use of the

traditional event study methodology, they debated its use saying that by making event portfolio

and studying whether the difference of portfolio return and CAPM return is equal to zero or not is

not suitable since the zero can be attributed to a number of reason like semi-strong inefficiency,

weak form inefficiency, error in calculation of beta/alpha or CAPM limitation, we can’t be certain

of the reason. In order to solve this issue, they formed portfolios based on historical excess returns

and categorized them as winner and losers and then studied the relationship between consistent

nonzero return behaviour of those winner and losers of months before and after the observed event

window. The methodology adopted by DeBondt and Thaler is still practiced when observing

overreaction in stock markets. They gathered NYSE stock returns data from CRSP database for

the period between January 1926 and December 1982. First, they calculated the calculated the

monthly residual returns of stocks for the following period of 72 months for each individual

security starting from January 1930. They redid the procedure 16 more times for 3 (non-

overlapping) year intervals. Second, starting from December 1932 (t=0, Portfolio formation), they

formed winner and loser portfolios based on CAR (cumulative abnormal returns) of stocks

covering (t-36) till (t=0). They also redid this procedure 16 more times for 3 (non-overlapping)

year intervals. Third, (t=0) up till (t+36) was considered as the post event evaluation window for

which CAR are also calculated both for winners as well as losers, they repeated the same method

16 times again considering 3 (non-overlapping) year intervals. Eventually, they computed average

cumulative abnormal returns for both winners and losers. They studied the average cumulative

abnormal returns in the post event window and found that loser portfolio ACAR were higher than

those of winner portfolios, furthermore they found that losers outperformed the market by an

5
average of 19%. Moreover, they observed that greater the CAR during the formation window

greater will be the effect of reversals, which proved their hypothesis and instated the fact that

markets are operated by investors who value recent information more than past information hence

proving the existence of overreaction phenomenon in the stock market.

Bernstein (1985) debates the findings and consequences of the study by deBondt and Thaler

(1985). In the study he debates the longer-term continuance of abnormal returns generated through

contrarian strategy and states that any such profits generated in a shorter time interval should be

eliminated by the investors. He goes on to explain the inefficiency of markets in integrating

information in a long-term but comments that short-term efficiency can be observed in

incorporating new information, further commenting on the issue he says that this phenomenon

might explain why contrarian strategies are profitable. He claims that long term inefficiencies can

be negated if each and every investor develop rational psychological attitudes and accept the actual

investment horizon as their individual investment time horizons.

DeBondt and Thaler (1987) published additional evidence to their earlier paper and in favour of

the overreaction phenomenon. They addressed the unresolved findings of the earlier study: (1)

large positive CAR of the loser portfolio in January and (2) asymmetry in reversals for loser and

winner portfolios. They go on to explain the characteristics of firms in both the observed portfolios

which was not present in the earlier study. They adopted the same methodology as in their earlier

paper. They calculated ACAR and CAR of the observed portfolios and found it to be consistent

with their earlier study, they also calculated Spearman rank correlations between appropriate pairs

of ACAR for the entire observed window, they found that loser tend to have excess returns

particularly in January, and those are negatively correlated to the pre event window returns. Excess

returns for winners are also observed in January which are negatively correlated to winner return

6
in prior December, they suspect that this effect is due to the tax loss harvesting effect. Authors

agreed that their study fails to explain the seasonality observed in excess return, they went on to

claim that overreaction effect is separate from the size effect, because the size effect is still

observed even if the effect of the losing firms is excluded. Their concluding remarks included that

excess returns phenomenon cannot be credited to size asymmetry, differences in Beta or Tax-loss

effect.

Another study which attributes the phenomenon of overreaction to size of the firm is Zarowin

(1989), findings of his paper contradict the findings of “Overreaction hypothesis” proposed by

DeBondt and Thaler (1985). Zarowin (1989) uses a trading rule that considers firms which had

especially good and bad earning years, then he constructs portfolios to see whether we can observe

investor overreaction to good and bad earning periods. He considered a post event window which

was 36 months long, winners and loser are categorised based on their earnings performance, which

is a measure used by the author. He claims that prior period losers will outperform prior period

winner in the subsequent post event window, he further added that when comparing loser with

winner of equal size the differences between earnings disappear. He concluded by saying that the

phenomenon of overreaction can be credited to size effect and not to investor overreacting

behaviour, because losers tend to be smaller firms than winners.

To further investigate the plausibility of his earlier findings Zarowin (1990) re-examines the

concept of stock market overreaction hypothesis pioneered by DeBondt and Thaler (1985). This

time around he accounts for the size disparities of winner and loser portfolios. He gathered data

used by DeBondt and Thaler (1985) and used the same methodology proposed by them. The results

of the regression confirmed the findings of DeBondt and Thaler (1987) i.e. prior losers tend to

outperform prior winners in subsequent post event window. He went on to conduct two tests, he

7
matched the sizes of both the winner and the loser firms and found that excess returns other than

those experienced in January are non-existent, which refers to the fact that these excess returns can

be attributed to tax-loss selling rather than to overreaction phenomenon. Second, he considered

two sets of data one in which winners are smaller than losers and the other in which losers are

smaller than winners and then examined both the sets separately, he observed that when losers are

smaller they over perform winners by 28.7 percent and similarly, when winners are smaller they

tend to outperform winners in the subsequent period. He claims that the overreaction hypothesis

is another expression of the already existing size effect phenomenon.

Conrad and Kaul (1993) studied the overreaction hypothesis and introduced evidence which

refutes the idea. They used a sample of NYSE firms observing a period between 1926-1988. They

utilized the methodology used by deBondt and Thaler (1985) to construct winner and loser

portfolios and then calculate the performance of these winners and losers in the subsequent period

using CAR method and alternate holding period technique. They presented that using CAR

method, the results are biased upwardly due to the effect of cumulation, they explained that upward

bias can be induced by errors such as bid-ask effect. Furthermore, they showed that using alternate

holding period technique removes the excess return of non-January months obtained by using long-

term contrarian strategies. They concluded by saying that longer term excess returns observed in

January periods cannot be credited to overreaction and there is no evidence suggesting that market

overreaction in non-January months.

Study conducted by Loughran and Ritter (1996) provides contrary evidence to the study conducted

by Conrad and Kaul (1993), They also tested both the methodologies used by Conrad and Kaul

(1993) and found that there is negligible difference between the returns calculated by both the

techniques. They explain the disparity between the two studies can be attributed to the different

8
statistical techniques adopted. They suggested that predictive ability of price is low by cross-

sectional regressions. They said that Conrad and Kaul (1993) have exaggerated the importance of

price in predicting and explaining cross-sectional returns while ignoring the correlation between

residual of stocks which leads to the misrepresentation of survivorship bias and t-statistic.

Lo and MacKinley (1990) provided evidence that abnormal returns can be generated through short-

run contrarian strategies using weekly portfolio returns (contrary to using returns generated in

longer-run horizon as suggested by past studies). They stated that it is important that we make a

distinction between short-term and long-term horizons since weekly variation differs from

movements in long-term horizon returns. This study is especially important because it quantifies

the amount of contrarian profit that can be credited to overreaction phenomenon. Their results

reveal that the amount of contrarian profit that can be credited to overreaction is less than 50

percent, they concluded that a significant portion of contrarian profit can be traced back to size

effects.

Jegadeesh and Titman (1995) contrary to Lo and MacKinley (1990) showed evidence that

contrarian strategies when applied to size-grouped portfolios do not generate significant abnormal

returns. They conducted two sets of tests, one for gauging the stock price reaction to common

information and the other for firm specific information. They suggested that overreaction exists

when considering firms specific information while there is a delayed reaction of stock prices when

considering common information. The delayed reaction did not contribute towards contrarian

profits and stock price overreaction to specific information may be likely due to the observed short-

run horizon contrarian profits. They also concluded that price reversals may be caused by liquidity

driven traders, and the increase in liquidity of the market will deem contrarian strategies less

profitable.

9
Rehman and Said (2019) also used the methodology used by DeBondt and Thaler (1985) in their

research to examine the overreaction of investor in the context of Pakistan Stock exchange,

however they took a relatively small sample size of 30 listed firms on the Pakistan stock exchange.

Their findings were in line with the findings of DeBondt and Thaler (1985), they observed loser

firms to outperform winner stocks in the observed time frame of the study. They also go on to

comment that since Pakistani stock market exhibits weak form efficiency thus, the phenomenon

of overreaction is observed, in a weak form efficient market, investors do not have access to

enough information which leads to irrational behaviour.

Kashif and Saad (2018) presented their findings which were similar to the original findings of

DeBondt and Thaler (1985), similar to extant literature they also used the methodology

popularized by DeBondt and Thaler (1985), however they used CAPM, 3-factor and 5-factor Fama

and French models. They concluded long-run contrarian strategy can be profitable in the context

of Pakistan stock exchange.

Another research (Parveen, Satti, Subhan & Jamil, 2020) published in the context of Pakistan stock

exchange noted that biases and heuristics are common place in investor psychology, Pakistan does

not have a developed market and investors are not informed enough to make rational decisions and

avoid the pre-existing notions in the market.

Recently (Huo & Qiu, 2020) presented their paper on the reaction of investors to the announcement

of COVID-19 lockdown in the context of the Chinese Stock Market. They examine the

overreaction effect on firm and industry level separately using the CAR methodology of DeBondt

and Thaler (1985). They found reversals both at the level of firm and industry and stated that the

higher the CAR in the event window, stronger will be the effect of reversals. Moreover, they noted

that reversals are stronger in firms with lower levels of institutional ownership which lead them to

10
believe that retail investors overreacted to the announcement more. Study is motivated by the

findings of Huo and Qiu (2020) and aims to test the hypothesis in the context of Pakistan stock

exchange.

When we look at the conclusions of the studies mentioned earlier it is evident that there is a lack

of consensus among researchers regarding the concept of overreaction, the decision to consider

overreaction as a general rule has long been and is still the topic of debate among academics, while

analysing the findings of these studies, overreaction phenomenon should be related to

representativeness bias (Yilmaz, 2016). Fama (1998) suggested two models explaining the

behaviour of investors and how the bias in investor judgement can give rise to overreaction. First

model is suggested by Barberis, Shleifer and Vishny (1998) while the second one is presented by

Daniel, Hirshleifer and Subramanyam (1998).

Barberis, Shleifer and Vishny (1998) proposed an investor sentiment model through which they

try to decipher the process of investor belief formation which induces market overreaction and

underreaction. They took into account two judgemental biases (1) Representativeness bias (which

is the tendency of the investor to overweight recent information of patterns while giving little

importance to overall picture) (Tversky & Kahneman, 1974) and (2) Conservatism bias (the

tendency of investors to slowly update their beliefs in light of new information) (Edwards, 1968).

Since we are concerned with overreaction, the judgemental bias that related to it is

representativeness bias. Their model goes on to suggest that investors believe that there are two

states that earnings follow rather than a random walk. State 1 is concerned with the underreaction

phenomenon while state 2 with the overreaction hypothesis. Study is concerned with overreaction

so we will explain state 2.

In this state, the investor believes that stock prices continue their previous trends, as in if the stock

11
price is on a rise it will continue to rise this belief system of investors lead to overreaction which

in turn leads to reversals over a longer time horizon as presented by DeBondt and Thaler (1985).

This belief of the investor follows Markov Process such that current state is predicted by the state

observed in the past period. For example, if two subsequent positive shocks are observed the

investor will believe that returns are following some sort of a trend.

Fama (1998) suggested that the model presented earlier can explain some of the anomalies of

efficient market hypothesis however extensive literature supports the notion of efficient markets.

An alternative model suggested by Daniel, Hirshleifer and Subramanyam (1998) states that

knowledgeable investors determine stock prices and are prone to “overconfidence” and “biased

self-attribution”. That is, they tend to overweight their private information much more than the

information that is publicly available, overweighting private signals may lead to overreaction to

private information while down weighting public signals may cause underreaction to publicly

available information. Both of these models are somewhat in agreement of their findings.

However, Fama (1998) debates that these models are not sufficient enough to explain the idea of

market efficiency and its anomalies because they fail to provide the bigger picture. Moreover, the

models might be able to suggest that overreaction is caused by investor optimistic behaviour, but

what were the circumstances which lead to that optimistic behaviour still remains a question.

Extant literature tries to attribute the phenomenon of overreaction to a number of factors such as

Size, January effect, state of the overall market and risk. Although contrary literature is present yet

it’s not sufficient, However the studies done by (Jegadeesh and Titman) and (DeBondt and Thaler)

still remain viable. Many studies suggest that overreaction cannot be explained by traditional asset

pricing models and behavioural models should be put to use to explain the phenomenon. However,

lack of any such testable and applicable theory remains a limitation.

12
2.1 Conceptual Framework

Extensive literature is available that explains the overreaction phenomenon and how price

reversals take place, Studies previously done on the topic poses two important suggestions. First,

that the phenomenon of overreaction goes against the widely established theory of efficient

markets. Second, the question arises whether an investor can successfully exploit the overreaction

phenomenon to earn some profit. The tendency of overreacting has been explained in two different

ways in extant literature, one is through the CAR methodology which makes use of Asset Pricing

Models, on the other hand studies done by Barberis, Shleifer and Vishny (1998) and Daniel,

Hirshleifer and Subramanyam (1998) presented behavioural models in order to explain the

phenomenon through behavioural lens.

The interest in the topic of behavioural finance for academic research has been growing recently

(Ma, Tang, & Hasan, 2005). The relationship of stock market overreaction with announcements

has been drawn from overreaction hypothesis (DeBondt, & Thaler, 1985).

R. H. Thaler was among the most renowned researchers in the field of behavioural finance.

DeBondt and Thaler (1985) tried to explain the stock market overreaction effect through the

research findings of experimental psychology. Overreaction tends to exist in stock markets of such

economies which tend to give greater importance to recent information while neglecting the prior

fundamentals of the stocks. Such behaviour of investors leads to overvaluation of stocks after

positive news and undervaluation after the announcement of some bad news. Subsequently, when

the overvalued stocks are reappraised the price tends to get back down to where it should have

been, in literature a term price reversals has been coined for such price decreases.

Atkins and Dyl (1990) explained the phenomenon by selecting 3 stocks for each of the movements

at the extreme end of the spectrum (i.e. stocks which showed highest percentage gain and the ones

13
with the highest percentage loss) for each day for a total of 300 randomly selected days during the

research window 1975 through 1984. They categorized the highest gains stocks as winner

portfolios and the ones with highest losses as loser portfolio. They concluded that loser portfolios

had significant price reversals while winner portfolios did not show any price reversal immediately

after the price increase. They also added that stocks with the highest bid-ask spread tend to earn

the largest abnormal returns.

Akhigbe, Gosnell, and Harikumar (1998) also examined overreaction by using sample of NYSE

stocks that had gained or lost the most in one trading day in 1992. Their results pointed at

significant price reversals for loser stocks during the period immediately following the

announcement. They found out that using major losers the abnormal returns earned through

reversals net of bid-ask spread are profitable. Which lead them to believe that their results are

consistent with that of overreaction hypothesis. However, after considering trading cost their

findings supported weak form efficiency.

Study uses the CAR methodology, for the purpose of which a dummy variable is constructed which

takes on a value of 1 for stocks which observed positive cumulative return in the event window

and 0 otherwise.

14
 Dummy Variable for CAR in CAR in the post event
the event window window (dependent)
(Independent)

B/M

INI ROA

EPS Size

Control Variables (CV)

Figure 1: Shows that relationship between our dependent, independent variable and control
variables

15
 CHAPTER 3 METHODOLOGY

This section of the paper talks about the methodology adapted when conducting the research, it

includes the design of the study, data collection methodology, explanations regarding the variables

considered in the study and the model adapted in the study.

3.1 Study design

Since the research is conducted on stocks listed on the stock market the population considered for

the study will be all the non-financial firms listed on Pakistan Stock Exchange, Sample was

collected from the population using the exclusion criteria prescribed in the literature, following

Liu, Stambaugh, and Yuan (2019), stocks listed before the year 2019 were considered and the data

was further filtered: (1) Stocks with missing returns data in the event window considered were

excluded (2) Stocks with missing returns data in the post event window were also excluded (3)

Stocks having less than 60 trading days in the estimation window were also excluded. Since our

objective was to gauge the impact of COVID-19 on Pakistan Stock Exchange, we used the Event

Study Design, in which we constructed multiple windows namely: the event window, estimation

window and the post event window. The estimation window was 6 months before the event date

i.e. from 1 September 2019 to 28 February 2020. Illustration of the event window is given below

16
 Event Window

Punjab went under lockdown,

Schools across the country
closed
Total Cases reached 136
Health emergency
announced in AJK
PHC ordered closure of all Call for researchers by the
courts & AJK, Sindh and federal government to bring
Balochistan went under ideas to curb the disease
lockdown
First 2 deaths reported and total GB went under lockdown Punjab announced relief pakage
tally reaches 302 indefinitely and interdistict and Sindh Government imposes
transport banned in KP further restrictions
Total tally stood at 495 Total tally reached 1197 &
KSE100 reaches 27000 points

13 Mar 14 Mar 15 Mar 16 Mar 17 Mar 18 Mar 19 Mar 20 Mar 21 Mar 22 Mar 23 Mar 24 Mar 25 Mar 26 Mar 27 Mar 28 Mar 29 Mar 30 Mar

KP announces stimulus pakages

Total Cases reach 53
and the federal government
PSL postponed indefinitely and All public & private gatherings resumes transport of goods on
Total Cases reached 237 banned in the capital highways
Health emergency declared in AJK went into lockdown and Announcement of volunteers
Balochistan and public transport Sindh Education minister, Saeed Corona Relief Tigers
was suspended Ghani tested positive
Government of Sindh announced
Lockdown, All international
flights were suspended and
Islamabad imposed Section 144

Figure 2: Event window for COVID-19 in Pakistan

3.2 Data Collection

The data required for the study was secondary in nature, so we gathered data for different variables

from multiple online sources, the data for KSE 100 index points, Closing prices for stocks, volume

was downloaded from the website of ksestocks, the data for no of shares, EBIT, Profit after tax,

Total Assets, Total book value of equity were downloaded from scstrade and the data for

institutional ownership was sourced from paid package offered by opendoors.pk. The data

collected from the sources was of the entire population of non-financial firms

3.3 Variables

3.3.1 Dependent Variable

The dependent variable considered in the study is cumulative abnormal returns in post event period

(CAR_P), construction of the variable is based on the market model:

AR it = R it − (αi + βi ⋅ R mt )

17
The alpha (α) and the beta (β) values were calculated using the intercept and the slope function in

excel on the return data of stock and the market in the estimation window, the returns of stock and

market are log returns which consider continuous compounding. Then the beta is multiplied with

the market return and then added with the intercept to get the value of expected return and then the

expected return is subtracted from the stocks actual return to get the abnormal returns, CAR are

basically the sum of all the previous abnormal returns for stock i

3.3.2 Independent Variable

The dependent variable considered in the study is a dummy variable for cumulative abnormal

returns (D_CAR), which takes a value of 1 for the period between March 13 to March 30 and 0

otherwise, for this we converted the format of dates so that stata is able to identify the dates in the

panel data and then we constructed a dummy using the dates generated. Also for industry analysis

we constructed a dummy for industries (D_IND) which takes a value of 1 if firm belong to industry

i, otherwise zero.

3.3.3 Control Variables

Following Huo and Qiu (2020), the control variables taken were (1) size, calculated as the log of

market capitalization of the firm (2) return on assets (ROA), calculated as the ratio between EBIT

and total assets (3) book to market (B/M), calculated as the ratio between book value of equity and

the market capitalization of the firm (4) earnings per share (EPS) calculated as the ratio between

profit after tax and no of shares outstanding (5) Institutional ownership (INI) is the percentage of

ownership of large entities in the firm.

18
 Table 1: Variable Summary

Variable Shortform Calculation

Actual Returns Ri Calculated as log of (Sn/Sn-1)
Market Returns Rm Calculated as log of (IPn/IPn-1)
Expected Returns E(R) Calculated using the Market model
Abnormal Returns AR Calculated as Ri-E(R)
Cumulative Abnormal Returns CAR Sum of all previous Abnormal returns
Earnings per Share EPS Profit after tax divided by No of shares outstanding
Return on assets ROA EBIT divided by book value of assets
Book to market B/M Book value of equity divided by market capitalization
Size Size Log of market capitalization
Post event CAR CAR_P Summation of all the AR in the event and the post event period
Dummy (CAR) D_CAR Value of 1 if in the event window 0 otherwise
Dummy (Industry) D_IND Value of 1 if industry i otherwise 0
Institutional Ownership INI Given as the percentage of ownership of large entities
Notes: SPn= Share Price of stock i at n (current), Sn-1= Share price of Stock i at n-1 (previous day), IPn= Index
Points of KSE-100 at n, IPn-1= Index points of KSE-100 at n-1

3.4 Model of the Study

3.4.1 Equation for firm level analysis (1)

𝑩
𝑪𝑨𝑹_𝑷𝒊,𝒕 = 𝜶 + 𝜷𝟏 (𝑫_𝑪𝑨𝑹)𝒊,𝒕 + 𝜷𝟐 (𝑺𝒊𝒛𝒆)𝒊,𝒕 + 𝜷𝟑 (𝑹𝑶𝑨)𝒊,𝒕 + 𝜷𝟒 (𝑴) + 𝜷𝟓 (𝑬𝑷𝑺)𝒊,𝒕 + 𝜺𝒊,𝒕
𝒊,𝒕

3.4.2 Equation for firm level analysis with INI (2)

𝑪𝑨𝑹_𝑷𝒊,𝒕 = 𝜶 + 𝜷𝟏 (𝑫_𝑪𝑨𝑹)𝒊,𝒕 + 𝜷𝟐 (𝑺𝒊𝒛𝒆)𝒊,𝒕 + 𝜷𝟑 (𝑹𝑶𝑨)𝒊,𝒕 + 𝜷𝟒 (𝑩/𝑴)𝒊,𝒕 + 𝜷𝟓 (𝑬𝑷𝑺)𝒊,𝒕 +

𝜷𝟔 (𝑰𝑵𝑰)𝒊,𝒕 + 𝜺𝒊,𝒕

3.4.3 Equation for Industry level analysis (3)

𝑪𝑨𝑹_𝑷𝒊𝒏𝒅,𝒕 = 𝜶 + 𝜷𝟏 (𝑫_𝑰𝑵𝑫)𝒊,𝒕 + 𝜷𝟐 (𝑫_𝑪𝑨𝑹)𝒊,𝒕 + 𝜷𝟑 (𝑺𝒊𝒛𝒆)𝒊,𝒕 + 𝜷𝟒 (𝑹𝑶𝑨)𝒊,𝒕 +

𝜷𝟓 (𝑩/𝑴)𝒊,𝒕 + 𝜷𝟔 (𝑬𝑷𝑺)𝒊,𝒕 + 𝜷𝟕 (𝑰𝑵𝑰)𝒊,𝒕 + 𝜺𝒊,𝒕

19
 CHAPTER 4 DATA ANALYSIS

This chapter includes all the analysis and statistical tests that the study employs in order to

understand the data and see whether the point of interest being stock price reversals can be

observed in the post event window. This chapter provides a detailed overview of the results and

what we can infer from those results in turn.

4.1 Descriptive statistics

Following is the table which shows the descriptive summary of the data used in the study,

descriptive statistics table provides a brief summary of the data which comes in handy when

dealing with large amount of data, taking a quick look at the table the variable of interest is

cumulative abnormal returns we can see that the minimum value of CAR is -98.71 which is due to

a company HIRAT which consistently traded well below the expected share price in the timeline

considered which contributed to a significant amount of negative CAR at the end of the post event

period , Similarly another company HINOON also performed well below the expected share price

consistently and its CAR at the end of the period was -28.97. On the other end of the spectrum the

maximum value of CAR observed was 1.774.

20
 Table 2: Descriptive Statistics

(1) (2) (3) (4) (5)

VARIABLES N Mean Std. Min Max

Ri 9,959 5.68e-05 0.0518 -0.511 0.438

Rm 9,959 -0.00116 0.0288 -0.233 0.136
E(R) 9,960 0.0114 0.152 -0.504 2.151
AR 9,960 -0.0113 0.155 -2.227 0.576
CAR 9,957 -0.280 4.187 -98.71 1.774
EPS 9,959 10.86 33.17 -130.0 200.6
ROA 9,959 0.0813 0.154 -0.586 1.232
B/M 9,959 1.672 2.720 -18.68 23.79
Size 10,204 14.97 2.016 9.318 20.02

Notes: Ri= Actual return of stock i (see Variable table), Rm= Market return of KSE-100, E(R)= Expected return
of stock i using market model, AR= Ri-E(R), CAR= Summation of all the previous abnormal returns, EPS=
Earnings per share calculated as the ratio between profit after tax and no of shares outstanding, ROA= Return
on assets, calculated as the ratio between EBIT and total book value of assets, B/M= Book to market, calculated
as the ratio between book value of equity and market capitalization, Size is calculated as the log of market
capitalization of the firm

4.2 Correlation analysis

Following is the table of correlation between the variables used in the study, since the variable of

interest here is cumulative abnormal return we would like to know is relationship with other

variables considered in the study, the relationship between AR and CAR is positive because as AR

increases the CAR will also increase, Expected return however has a negative relationship because

as the expected return increases the negative term in the market model increases which eventually

decreases the CAR value, CAR has a positive relationship with all the other control variables

considered in the study with the highest correlation with ROA, which indicates that all the variables

move with CAR in a positive linear fashion.

21
 Table 3: Correlation Table

Ri Rm E(R) AR CAR EPS ROA B/M Size

Ri 1
Rm 0.476 1
E(R) 0.1072 0.1921 1
AR 0.2289 -0.029 -0.943 1
CAR 0.0026 -0.009 -0.85 0.8331 1
EPS -0.008 -1E-04 -0.052 0.0483 0.0421 1
ROA -0.018 -8E-04 -0.19 0.1799 0.1625 0.3517 1
B/M -0.018 -0.006 -0.07 0.0626 0.0568 -0.031 0.0156 1
Size 0.0077 0.0043 -0.085 0.0859 0.0741 0.3208 0.2676 -0.25 1
Notes: Ri= Actual return of stock i (see Variable table), Rm= Market return of KSE-100, E(R)= Expected return
of stock i using market model, AR= Ri-E(R), CAR= Summation of all the previous abnormal returns, EPS=
Earnings per share calculated as the ratio between profit after tax and no of shares outstanding, ROA= Return
on assets, calculated as the ratio between EBIT and total book value of assets, B/M= Book to market, calculated
as the ratio between book value of equity and market capitalization, Size is calculated as the log of market
capitalization of the firm

4.3 Regression analysis

We further go on to confirm our hypothesis of reversals by conducting a regression analysis on

our data, since we want to see whether reversals are observed during the event on the level of

individual firms and on the level of industry, we perform two different regressions in order to

substantiate the claim of overreaction.

4.4 Reversals at firm level

To gauge the degree of reversals we perform OLS regression, where the independent variable is

CAR in the post event window, the dependent variable is a dummy (D_CAR) and the control

variables include Size, ROA, B/M, EPS and INI. Following is the table of regression on firm level.

22
 Table 4: Reversals at firm level

Dependent Variable (CAR_P)

VARIABLES (1) (2) (3) (4) (5)

D_CAR 0.272*** 0.263** 0.263**

(0.105) (0.103) (0.104)
Size 0.124*** 0.120*** 0.122***
(0.0228) (0.0230) (0.0230)
ROA 4.236*** 4.252*** 4.245***
(0.292) (0.293) (0.292)
B/M 0.104*** 0.106*** 0.105***
(0.0157) (0.0158) (0.0158)
EPS -0.00373*** -0.00366*** -0.00365***
(0.00137) (0.00138) (0.00138)
INI 0.315 0.459 0.454
(0.349) (0.345) (0.345)
Constant -0.335*** -2.662*** -0.287*** -2.569*** -2.642***
(0.0469) (0.345) (0.0425) (0.346) (0.347)

Observations 9,957 9,957 9,908 9,908 9,908

R-squared 0.001 0.033 0.000 0.032 0.033
Standard errors in parentheses
*** p<0.01, ** p<0.05, * p<0.1
Notes: D_CAR= Dummy of CAR which takes a value of 1 if the CAR belong to the event period and zero
otherwise, EPS= Earnings per share calculated as the ratio between profit after tax and no of shares
outstanding, ROA= Return on assets, calculated as the ratio between EBIT and total book value of assets, B/M=
Book to market, calculated as the ratio between book value of equity and market capitalization, Size is
calculated as the log of market capitalization of the firm, INI= percentage of institutional ownership, we created
a dummy for it to identify firms with higher institutional ownership firms having more than 50 percent
institutional ownership were assigned 1 and zero otherwise.

Taking a quick look at the results we observe that reversals are evident since intercept is negative

and is statistically significant, however when the D_CAR is considered reversals are observed but

at a much lower rate. In column (5) however when all the control variables are taken into

consideration the results are statistically significant and reversals are observed which is in line

with literature, a point here to note is that institutional ownership came out to be insignificant and

when institutional ownership is considered the overreaction phenomenon is observed but not as

23
much which indicates that during high levels of uncertainty, retail investors react much more to

negative information than institutional owners, here the overreaction to COVID-19 is mainly

driven by retail investors.

4.5 Reversals at industry level

Study uses regression to analyze the effect of the event (COVID-19) on different non-financial

industries on Pakistan stock exchange, here we create another dummy for industries to individually

analyze CAR of each industry D_IND is a dummy which observes a value of 1 if the stock belongs

to industry i and zero otherwise, the dummies created were 26 in total for each different industry

and then ran regression using the CAR_P as the independent variable and dependent variable is

D_IND and the control variables are Size, B/M, EPS, ROA.

24
 Table 5: Reversals at Industry level
CAR Coef. St.Err t-value p-value Sig.
SUGAR & ALLIED -0.087 0.551 -0.16 0.875
PHARMACEUTICALS -2.236 0.572 -3.91 0.000 ***
CEMENT 0.010 0.546 0.02 0.985
TEXTILE COMPOSITE -0.257 0.547 -0.47 0.639
POWER GENERATION & -0.060 0.555 -0.11 0.915
DISTIBUTION
AUTOMOBILE PARTS & -0.122 0.576 -0.21 0.832
ACCESSORIES
CHEMICAL -0.121 0.543 -0.22 0.823
AUTOMOBILE -0.115 0.556 -0.21 0.836
ASSEMBLER
OIL & GAS MARKETING -0.096 0.582 -0.17 0.869
FOOD & PERSONAL -0.071 0.555 -0.13 0.898
CARE
ENGINEERING -0.076 0.581 -0.13 0.896
TEXTILE SPINNING -2.909 0.545 -5.34 0.000 ***
REFINERY -0.010 0.603 -0.02 0.987
LEATHER & TANNERIES -0.233 0.633 -0.37 0.713
GLASS & CERAMICS -0.051 0.574 -0.09 0.930
WOOLLEN -0.252 0.850 -0.30 0.767
PAPER & BOARD -0.050 0.575 -0.09 0.931
FERTILIZER -0.035 0.578 -0.06 0.952
MISC 0.003 0.563 0.01 0.996
TEXTILE WEAVING -0.065 0.585 -0.11 0.911
SYNTHETIC & RAYON -0.099 0.677 -0.15 0.883
TECHNOLOGY & 0.089 0.568 0.16 0.876
COMMUNICATION
TOBBACCO -0.204 0.819 -0.25 0.803
OIL & GAS -0.041 0.603 -0.07 0.946
EXPLORATION
CABLE & ELECTRICAL -0.122 0.611 -0.20 0.842
GOODS
TRANSPORT -0.085 0.631 -0.13 0.893
_cons 0.120 0.526 0.23 0.820

Mean dependent var -0.282 SD dependent var 4.198

R-squared 0.043 Number of obs 9908.000
F-test 17.185 Prob > F 0.000
Akaike crit. (AIC) 56158.910 Bayesian crit. (BIC) 56353.339

*** p<0.01, ** p<0.05, * p<0.1

The results came out to be as expected, the textile spinning industry expected the most overreaction

in the event period followed by the pharmaceuticals industry, both came out to be statistically

significant and negative. The COVID-19 outbreak caused a rise in demand for medical equipment

and products and the retail investors overreacted in favor of pharmaceuticals industry which is

25
evident from the price reversals in the subsequent post event period. Pakistan is one of the biggest

exporters of textile products worldwide, since China was especially hit by the pandemic the

uncertainty in their ability to provide exports of textile needed, shifted the demand towards

Pakistan which in turn caused the retail investors to overreact to this information which is evident

from the reversals observed shortly afterwards.

26
 CHAPTER 5 CONCLUSION

COVID-19 is an unprecedented event which has caused uncertainty regarding many things

surrounding the outbreak, there has been especially disastrous impact on the economic wheel of

the country, which has led to many stringent measures by the government to curb the disease,

which have a direct impact on the economic wellbeing of the state. The announcement of lockdown

has happened in the country in multiple stages since it was a developing scenario smart lockdown

were put in place where the condition had worsened and has affected many businesses across the

country, and it also impacted the companies listed on the Pakistan stock exchange. Since the impact

was felt in almost every sector the study took the entire window from 13 March till 30 March 2020.

Study found there were significant reversals at firm level as well as on the level of industry, the

stocks having the most positive CAR in the event window were found to have the strongest

reversals, hence the overreaction in the Pakistan stock exchange was mainly found in the industries

having the most CAR, that is the pharmaceuticals industry and the textile spinning industry. In

addition to that the study found that the firms with lower level of institutional ownership have

lower reversals which in turn means that the firms where retail investors are dominant had the

most overreaction. In other words, the overreaction observed was mainly the cause of retail

investor overreacting to the announcement of COVID-19 lockdown.

5.1 Implications and recommendations

COVID-19 was unexpected and sudden and the scale and extent of it could not have been predicted

beforehand with the existing policies in place, authorities and those charged with governance of

the state have a lot to learn from this pandemic so that effective preemptive measure can be

designed and put in place for the future, this pandemic has hit the general populace hard in many

ways, the authorities should design stimulus packages for the industries in distress during that

27
period and also for the general public because in scenarios like these household spending usually

come to halt and with packages like these government can ensure the demand for industrial goods

doesn’t come crumbling down and the economic wheel keeps turning. Also, the government

should try to calm the chaos and project a composed image which would instill confidence in the

eyes of the public.

5.2 Limitations

The study uses the event study methodology and the limitations inherent to the methodology may

carry through, market inefficiencies may cause the information to not fully incorporate in the event

period observed, Other co-existing event also happening at the same time might affect the validity

of the effect observed in the study which could again lead to bias. On the other hand, there is no

rule for determining the length of the estimation and the event period, the length of the period

observed might skew the result. The calculation of the expected returns is also a subject of

disagreement, some models have their own set of limitations and if the expected returns are not

calculated accurately, it might affect the entire study. Lastly, the availability of data remains a

concern in study, since not every stock trade everyday and the some have missing values in either

the estimation window or the event window itself also the other variables such as the data for

control variables might also be missing which would lead to the exclusion of such firms and might

have an effect on the result.

28
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