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A New Pseudo-Bayesian Model of Investors' Behavior in Financial Crises

Author

Listed:
  • Guo, Xu
  • Lam, Kin
  • Wong, Wing-Keung
  • Zhu, Lixing
Abstract
In this paper, we introduce a new pseudo-Bayesian model to incorporate the impact of a financial crisis and establish some properties of stock returns and investors' behavior during a financial crisis and subsequent recovery. Our approach provides a quantitative description for investors' representative and conservative heuristics by assuming that the earnings shock of an asset follows a modified random walk model to incorporate the impact of a financial crisis on the earnings of a firm. By using this model setup, we first establish some properties on the expected earnings shock and its volatility. Thereafter, we derive some properties of investors' behavior on the stock price and its volatility during a financial crisis and subsequent recovery. Last, we develop properties to explain some market anomalies, including short-term underreaction, long-term overreaction, and excess volatility during a financial crisis and subsequent recovery.

Suggested Citation

  • Guo, Xu & Lam, Kin & Wong, Wing-Keung & Zhu, Lixing, 2012. "A New Pseudo-Bayesian Model of Investors' Behavior in Financial Crises," MPRA Paper 42535, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:42535
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    File URL: https://mpra.ub.uni-muenchen.de/42535/1/MPRA_paper_42535.pdf
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    References listed on IDEAS

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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Bayesian model; Representative and conservative heuristics; Underreaction; Overreaction; Stock price; Stock return; Financial crisis;
    All these keywords.

    JEL classification:

    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C01 - Mathematical and Quantitative Methods - - General - - - Econometrics

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