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Measuring the Behavioral Component of Financial Fluctuations: An Analysis Based on the S&P 500

Massimiliano Caporin, Luca Corazzini and Michele Costola

CREATES Research Papers from Department of Economics and Business Economics, Aarhus University

Abstract: We study the evolution of the behavioral component of the financial market by estimating a Bayesian mixture model in which two types of investors coexist: one rational, with standard subjective expected utility theory (SEUT) preferences, and one behavioral, endowed with an S-shaped utility function. We perform our analysis by using monthly data on the constituents of the S&P 500 index from January 1962 to April 2012. We assume that agents take investment decisions by ranking the alternative assets according to their performance measures. A tuning parameter blending the rational and the behavioral choices can be estimated by using a criterion function. The estimated parameter can be interpreted as an endogenous market sentiment index. This is confirmed by a number of checks controlling for the correlation of our endogenous index with measures of (implied) financial volatility, market sentiments and financial stress. Our results confirm the existence of a significant behavioral component that reaches its peaks during periods of recession. Moreover, after controlling for a number of covariates, we observe a significant correlation between the estimated behavioral component and the S&P 500 return index.

Keywords: Investment decision; behavioral agents; mixture model; behavioral expectations (search for similar items in EconPapers)
JEL-codes: C58 G01 G02 G11 G17 (search for similar items in EconPapers)
Pages: 45
Date: 2014-09-30
New Economics Papers: this item is included in nep-fmk and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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