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

Xu GUO, Michael MCALEER, Wing Keung WONG, Lixing ZHU

Research output: Journal PublicationsJournal Article (refereed)Researchpeer-review

3 Citations (Scopus)

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.
Original languageEnglish
Pages (from-to)346-358
Number of pages13
JournalNorth American Journal of Economics and Finance
Volume42
DOIs
Publication statusPublished - 1 Nov 2017
Externally publishedYes

Fingerprint

Bayesian approach
Underreaction
Financial crisis
Excess volatility
Overreaction
Assets
Asset pricing
Market anomalies
Investor behavior
Anomaly
Exponential family
Behavioral finance
Asset pricing models
Stock prices
Magnitude effect
Asymmetric information
Random walk model

Keywords

  • Bayesian model
  • Excess volatility
  • Financial crises
  • Magnitude effects
  • Representative and conservative heuristics
  • Underreaction and overreaction

Cite this

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title = "A Bayesian approach to excess volatility, short-term underreaction and long-term overreaction during financial crises",
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.",
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A Bayesian approach to excess volatility, short-term underreaction and long-term overreaction during financial crises. / GUO, Xu; MCALEER, Michael; WONG, Wing Keung; ZHU, Lixing.

In: North American Journal of Economics and Finance, Vol. 42, 01.11.2017, p. 346-358.

Research output: Journal PublicationsJournal Article (refereed)Researchpeer-review

TY - JOUR

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AU - GUO, Xu

AU - MCALEER, Michael

AU - WONG, Wing Keung

AU - ZHU, Lixing

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AB - 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.

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KW - Magnitude effects

KW - Representative and conservative heuristics

KW - Underreaction and overreaction

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