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

Listed author(s):
  • 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)

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.

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Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 16-003/III.

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Date of creation: 15 Jan 2016
Handle: RePEc:tin:wpaper:20160003
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