A Bayesian approach to excess volatility, short-term underreaction and long-term overreaction during financial crises

Xu Guo, Michael McAleer, Wing-Keung Wong and Lixing Zhu

The North American Journal of Economics and Finance, 2017, vol. 42, issue C, 346-358

Abstract: In this paper, we introduce a new Bayesian approach to explain some market anomalies during financial crises and subsequent recovery. We assume that the earnings shock of an asset follows a random walk model with and without drift to incorporate the impact of financial crises. We further assume the earning shock follows an exponential family distribution to accommodate symmetric as well as asymmetric information. By using this model setting, we develop some properties on the expected earnings shock and its volatility, and establish properties of investor behavior on the stock price and its volatility during financial crises and the subsequent recovery. Thereafter, we develop properties to explain excess volatility, short-term underreaction, long-term overreaction, and their magnitude effects during financial crises and the subsequent recovery. We also explain why behavioral finance theory could be used to explain many of the asset pricing anomalies, but traditional asset pricing models cannot achieve this aim.

Keywords: Bayesian model; Representative and conservative heuristics; Excess volatility; Underreaction and overreaction; Magnitude effects; Financial crises (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (24)

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Related works:
Working Paper: A Bayesian Approach to Excess Volatility, Short-term Underreaction and Long-term Overreaction during Financial Crises (2016)
Working Paper: A Bayesian Approach to Excess Volatility, Short-term Underreaction and Long-term Overreaction During Financial Crises (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecofin:v:42:y:2017:i:c:p:346-358

DOI: 10.1016/j.najef.2017.08.001

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