The dynamics of familiarity bias during extreme events: Investor responses across industries

The efficient market hypothesis is struggling to explain market behavior during rare, high-impact events. In such uncertain times, familiarity guides the decisions, allowing the brain to rely on subconscious processing for optimal outcomes. Therefore, this research aimed to examine the relationship between elevated familiarity bias and abnormal returns during rare events. Data were collected from all companies listed and active on the Indonesia Stock Exchange from 1997 to 2020. A systematic sampling method was used to establish the sample criteria, which led to a total of 5,615 observations derived from the number of trading days over 23 years across nine industries on the Indonesian Stock Exchange. The data collected were analyzed using the traditional Capital Asset Pricing Model, prospect theory and extending the Fama and French three-factor model with the addition of a psychological factor. The results show that familiarity bias behavior does not uniformly occur across all industries in Indonesia during rare events. The industries negatively impacted by these events include agriculture, consumer goods, trade services and investment, finance, basic industry, chemicals, mining, miscellaneous industries, property, real estate and building construction at values of –0.0847, –0.0946, –0.0721, -0.0405, –0.0717, –0.1258, –0.024, and –0.0805, respectively. A positive impact was only found in the infrastructure, utilities, and transportation industry at 0.0028. In conclusion, stock market behavior also affects the economy from a behavioral finance perspective.