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

Author

Listed:
  • Xu Guo

    (Nanjing University of Aeronautics and Astronautics)

  • Michael McAleer

    (National Tsing Hua University, Taiwan; Erasmus University Rotterdam, the Netherlands; Complutense University of Madrid, Spain)

  • Wing-Keung Wong

    (Hong Kong Baptist University, Hong Kong, PR China)

  • Lixing Zhu

    (Hong Kong Baptist University, Hong Kong, PR China)

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 properties 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

  • Xu Guo & Michael McAleer & Wing-Keung Wong & Lixing Zhu, 2016. "A Bayesian Approach to Excess Volatility, Short-term Underreaction and Long-term Overreaction During Financial Crises," Tinbergen Institute Discussion Papers 16-003/III, Tinbergen Institute.
  • Handle: RePEc:tin:wpaper:20160003
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    Citations

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    Cited by:

    1. Chia-Lin Chang & Michael McAleer & Wing-Keung Wong, 2018. "Management Information, Decision Sciences, and Financial Economics: A Connection," Tinbergen Institute Discussion Papers 18-004/III, Tinbergen Institute.
    2. Chang, C-L. & McAleer, M.J. & Wong, W.-K., 2018. "Decision Sciences, Economics, Finance, Business, Computing, and Big Data: Connections," Econometric Institute Research Papers 18-024/III, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
    3. Chia-Lin Chang & Michael McAleer & Wing-Keung Wong, 2018. "Big Data, Computational Science, Economics, Finance, Marketing, Management, and Psychology: Connections," Journal of Risk and Financial Management, MDPI, Open Access Journal, vol. 11(1), pages 1-29, March.

    More about this item

    Keywords

    Bayesian model; representative and conservative heuristics; excess volatility; underreaction; overreaction; magnitude effects; financial crises;

    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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