A note on Stein’s overreaction puzzle

Yuehao Lin () and Thorsten Lehnert ()
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Yuehao Lin: University of Luxembourg
Thorsten Lehnert: University of Luxembourg

Decisions in Economics and Finance, 2020, vol. 43, issue 1, No 14, 269-276

Abstract: Abstract Recently, Christoffersen et al. (Rev Financ Stud 26(8):1963–2006, 2013) argue that the overreaction puzzle of Stein (J Finance 44(4):1011–1023, 1989) can be explained by a variance-dependent pricing kernel. In this note, we challenge this view. Our theoretical results are in line with their argument that the variance under risk-neutral measure is more persistent than the variance under physical measure due to a negative variance risk premium. But our results do not support their argument that the more persistent variance is able to qualitatively explain Stein’s findings. We show theoretically that the persistence of the volatility cannot amplify the movements of long-term variance to short-term fluctuations in variance and, therefore, conclude that Stein’s overreaction puzzle is still unsolved.

Keywords: Pricing kernel; Stochastic volatility; Overreaction; Variance risk (search for similar items in EconPapers)
JEL-codes: G12 (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1007/s10203-019-00244-z

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