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A Bayesian Approach to Excess Volatility, Short-term Underreaction and Long-term Overreaction during Financial Crises

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  • Guo, X.
  • McAleer, M.J.
  • Wong, W.-K.
  • Zhu, L.

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.

Suggested Citation

  • Guo, X. & McAleer, M.J. & Wong, W.-K. & Zhu, L., 2016. "A Bayesian Approach to Excess Volatility, Short-term Underreaction and Long-term Overreaction during Financial Crises," Econometric Institute Research Papers EI2016-01, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
    • Handle: RePEc:ems:eureir:79730
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    More about this item

    Keywords

    Bayesian model; representative and conservative heuristics; excess volatility; underreaction; overreaction; magnitude effects; financial crises;
    All these keywords.

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • G01 - Financial Economics - - General - - - Financial Crises
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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