Equilibrium Portfolio Strategies in the Presence of Sentiment Risk and Excess Volatility

Bernard Dumas (), Alexander Kurshev and Raman Uppal

Journal of Finance, 2009, vol. 64, issue 2, 579-629

Abstract: Our objective is to identify the trading strategy that would allow an investor to take advantage of “excessive” stock price volatility and “sentiment” fluctuations. We construct a general equilibrium “difference‐of‐opinion” model of sentiment in which there are two classes of agents, one of which is overconfident about a public signal, while still optimizing intertemporally. Overconfident investors overreact to the signal and introduce an additional risk factor causing stock prices to be excessively volatile. Consequently, rational investors choose a conservative portfolio; moreover, this portfolio depends not just on the current price divergence but also on their prediction about future sentiment and the speed of price convergence.

Date: 2009
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Citations: View citations in EconPapers (181)

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https://doi.org/10.1111/j.1540-6261.2009.01444.x

Related works:
Working Paper: Equilibrium Portfolio Strategies in the Presence of Sentiment Risk and Excess Volatility (2007)
Working Paper: Equilibrium Portfolio Strategies in the Presence of Sentiment Risk and Excess Volatility (2007)
Working Paper: Equilibrium Portfolio Strategies in the Presence of Sentiment Risk and Excess Volatility (2007)
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