Price extremes and asymmetric dependence structures in stock returns: the emerging market evidence

Abstract

Purpose

Equity research in experimental psychology reveals investors' overreactions to bad news events. This study of asymmetric price structures in equity markets investigates whether such behavior predicts stock returns in an emerging market of India.

Design/methodology/approach

The research decomposes Bombay Stock Exchange (BSE) Sensex returns into Extremely Positive Returns (EPR) and Extremely Negative Returns (ENR) based on extreme values at first and then tests their lead–lag relations.

Findings

The empirical finding is consistent with the existing evidence of asymmetric news effects on stock returns in India. In precise, ENR robustly predicts one-month-ahead EPR for the sample period from January 1991 to March 2020. This predictive power persists even in the presence of popular valuation ratios and business cycle variables.

Practical implications

The paper explains the rationale of extreme value modeling in price forecasting. Investors can find additional utility gains from market cycle information while predicting extreme returns in Indian stock market.

Originality/value

The paper is unique to understand business cycle effects in extreme return reversals in emerging markets.

Citation

Thazhungal Govindan Nair, S. (2022), "Price extremes and asymmetric dependence structures in stock returns: the emerging market evidence", Journal of Economic Studies, Vol. 49 No. 8, pp. 1502-1523. https://doi.org/10.1108/JES-10-2021-0507