Can Behavioral Models Explain the behavior of Korean Stock Prices?

Abstract

We investigated whether existing behavioral models can sufficiently explain the behavior of Korean stock prices, especially such behaviors as the observed short-horizon continuation and long-horizon reversals in KOSPI returns. To accomplish this purpose, we used Lee`s (2003) identification method of tangible and intangible shocks based on a structural VAR model in order to evaluate the conventional dividend discount model and the residual income model. In this study, we could observe Korean investors` tendency to overreact to intangible information and to underreact initially to tangible information, with no significant reversal associated with tangible information in the long run. These findings are similar to those observed in the U.S. They are compatible with the predictions of behavioral models that incorporate overconfidence of investors in their private information. As a result of this study, we could also ascertain that the residual income model provides a better valuation tool than the dividend discount model for the KOSPI returns.