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: Contribution to journalArticle

4 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 (US)
Pages (from-to)346-358
Number of pages13
JournalNorth American Journal of Economics and Finance
Volume42
DOIs
StatePublished - Nov 2017

Fingerprint

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

All Science Journal Classification (ASJC) codes

  • Finance
  • Economics and Econometrics

Cite this

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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, 11.2017, p. 346-358.

Research output: Contribution to journalArticle

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