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A decision-theoretic model of asset-price underreaction and overreaction to dividend news

Alexander Ludwig and Alexander Zimper

No 201223, Working Papers from University of Pretoria, Department of Economics

Abstract: We combine new developments in decision theory with a standard consumption-based asset-pricing framework. In our model the efficient market hypothesis is violated if and only if agents' beliefs express ambiguity about the stochastic process driving economic fundamentals. Asset price fluctuations result because agents with ambiguous beliefs are prone to a confirmatory bias in the interpretation of new information. We demonstrate that our approach gives rise to price-patterns of "underreaction" and "overreaction" to news about dividend payments. Although these empirical phenomena have received significant attention in the behavioral finance literature, we argue that our decision-theoretic underpinning of psychological attitudes has a less ad hoc flavor than existing approaches.

Keywords: Choquet Expected Utility Theory; Portfolio Choice; Asset Pricing Puzzles (search for similar items in EconPapers)
Pages: 49 pages
Date: 2012-06
New Economics Papers: this item is included in nep-fmk, nep-neu and nep-upt
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http://www.up.ac.za/media/shared/61/WP/wp296.zp39567.pdf (application/pdf)

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Journal Article: A decision-theoretic model of asset-price underreaction and overreaction to dividend news (2013) Downloads
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