Overreaction Hypothesis

The Overreaction Hypothesis suggests that investors sometimes react too strongly to recent news or events, causing initial market overreactions—either rentensely optimistic or pessimistic. Once the overreaction is recognized, prices often adjust back toward their true value, making the initial overreaction a temporary mispricing. This idea helps explain why markets sometimes experience sharp swings that don't align with fundamentals, emphasizing that emotional responses and biases can influence market behavior beyond rational analysis.