is really a more general question here. What are the equilibria conditions for markets in which some agents are not rational in the sense that they fail to revise their expectations according to Bayes'rule? Russell and Thaler [24] address this issue. They conclude that the existence of some rational agents is not sufficient to guarantee a rational expectations equilibrium in an economy with some of what they call quasi-rational agents. ( The related question of market equilibria with agents having heterogeneous expectations is investigated by Jarrow [13].) While we are highly sensitive to these issues, we do not have the space to address them here Instead, we will concentrate on an empirical test of the overreaction hypothesis. If stock prices systematically overshoot, then their reversal should be predict able from past return data alone, with no use of any accounting data such as earnings. Specifically, two hypotheses are suggested: (1)Extreme movements in stock prices will be followed by subsequent price movements in the opposite direction.(2) The more extreme the initial price movement, the greater will be the subsequent adjustment. Both hypotheses imply a violation of weak-form market efficiency. To repeat, our goal is to test whether the overreaction hypothesis is predictive In other words, whether it does more for us than merely to explain, ex post, the P/E effect or Shiller's results on asset price dispersion. The overreaction effect deserves attention because it represents a behavioral principle that may apply in many other contexts. For example, investor overreaction possibly explains Shill er's earlier [26] findings that when long-term interest rates are high relative to short rates, they tend to move down later on. Ohlson and Penman [20 have further suggested that the increased volatility of security returns following stock splits may also be linked to overreaction. The present empirical tests are to our knowledge the first attempt to use a behavioral principle to predict a new market The remainder of the paper is organized as follows. The next section describes the actual empirical tests we have performed. Section II describes the results Consistent with the overreaction hypothesis, evidence of weak-form market inefficiency is found. We discuss the implications for other empirical work on asset pricing anomalies. The paper ends with a brief summary of conclusions I. The Overreaction Hypothesis: Empirical Tests The empirical testing procedures are a variant on a design originally proposed by beaver and Landsman [5]in a different context. Typically, tests of semistror form market efficiency start, at time t=0, with the formation of portfolios on the basis of some event that affects all stocks in the portfolio, say, an earnings announcement. One then goes on to investigate whether later on(t>0)the estimated residual portfolio return iptmeasured relative to the single-period CAPM--equals zero Statistically significant departures from zero are interpreted as evidence consistent with semistrong form market inefficiency, even though the results may also be due to misspecification of the CAPm, misestimation of the relevant alphas and or betas or simply market inefficiency of the weak form