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

No EI2016-01, Econometric Institute Research Papers from Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute

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 take care of 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 prop- erties of investor behavior on the stock price and its volatility during financial crises and subsequent recovery. Thereafter, we develop properties to explain excess volatility, short-term underreaction, long-term overreaction, and their magnitude effects during financial crises and subsequent recovery.

Keywords: Bayesian model; representative and conservative heuristics; excess volatility; underreaction; overreaction; magnitude effects; financial crises (search for similar items in EconPapers)
JEL-codes: C11 G01 G11 (search for similar items in EconPapers)
Pages: 26
Date: 2016-01-01
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Related works:
Journal Article: A Bayesian approach to excess volatility, short-term underreaction and long-term overreaction during financial crises (2017)
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:ems:eureir:79730

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