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Chapter 8. The Worst is Behind You: The ... > Theoretical Roots: The Contrarian St...

Theoretical Roots: The Contrarian Story

To understand the contrarian impulse, you first need to establish a link between prices and information. As new information comes out about a company, its stock price will undoubtedly move, but by how much and what would constitute an overreaction? This section begins by answering these questions. It then considers an alternative view, which is that prices are not predictable and follow a random walk; this would represent a rejection of the notion that markets over react to new information. The section closes with an examination of the psychological underpinnings of contrarian investing. In other words, what is it about human behavior that leads to overreaction in the first place?

Information and Price

Any debate about whether markets overreact to new information has to begin with a discussion of the relationship between prices and information. After all, in every market, new information will cause stock prices to move; unexpected good news will generally push up stock prices, whereas unexpected bad news will cause prices to drop. If markets make mistakes in their assessments, the prices will be different from the true values of the underlying assets.


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