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A pseudo-Bayesian model in financial decision making with implications to market volatility, under- and overreaction

  • Lam, Kin
  • Liu, Taisheng
  • Wong, Wing-Keung

This paper develops a model of weight assignments using a pseudo-Bayesian approach that reflects investors' behavioral biases. In this parsimonious model of investor sentiment, weights induced by investors' conservative and representative heuristics are assigned to observations of the earning shocks of stock prices. Such weight assignments enable us to provide a quantitative link between some market anomalies and investors' behavioral biases. The seriousness of an anomaly can be quantitatively assessed by investigating into its dependency on weights. New results other than the short-run underreaction and long-run overreaction can be derived and new hypotheses can be formed.

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File URL: http://www.sciencedirect.com/science/article/pii/S0377-2217(09)00503-7
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Article provided by Elsevier in its journal European Journal of Operational Research.

Volume (Year): 203 (2010)
Issue (Month): 1 (May)
Pages: 166-175

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Handle: RePEc:eee:ejores:v:203:y:2010:i:1:p:166-175
Contact details of provider: Web page: http://www.elsevier.com/locate/eor

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  12. Wing-Keung Wong & Raymond H. Chan, 2004. "On the Estimation of Cost of Capital and its Reliability," Departmental Working Papers wp0401, National University of Singapore, Department of Economics.
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