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A decision-theoretic model of asset-price underreaction and overreaction to dividend news

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  • Alexander Ludwig
  • Alexander Zimper

Abstract

We combine new developments in decision theory with a standard consumption-based asset-pricing framework. In our model the efficient market hypothesis is violated if and only if agents’ beliefs express ambiguity about the stochastic process driving economic fundamentals. Asset price fluctuations result because agents with ambiguous beliefs are prone to a confirmatory bias in the interpretation of new information. We demonstrate that our approach gives rise to price-patterns of “underreaction” and “overreaction” to news about dividend payments. Although these empirical phenomena have received significant attention in the behavioral finance literature, we argue that our decision-theoretic underpinning of psychological attitudes has a less ad hoc flavor than existing approaches. Copyright Springer-Verlag 2013

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  • Alexander Ludwig & Alexander Zimper, 2013. "A decision-theoretic model of asset-price underreaction and overreaction to dividend news," Annals of Finance, Springer, vol. 9(4), pages 625-665, November.
  • Handle: RePEc:kap:annfin:v:9:y:2013:i:4:p:625-665
    DOI: 10.1007/s10436-012-0208-z
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    3. Giulio Bottazzi & Pietro Dindo & Daniele Giachini, 2019. "Momentum and reversal in financial markets with persistent heterogeneity," Annals of Finance, Springer, vol. 15(4), pages 455-487, December.

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    More about this item

    Keywords

    Choquet expected utility theory; Portfolio choice; Asset pricing puzzles; Overreaction; Underreaction; C62; D81; G11; G12;
    All these keywords.

    JEL classification:

    • C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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