Stock Market Overreactions to Bad News in Good Times: A Rational Expectations Equilibrium Model

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ID: 298171
1999
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Abstract
This article presents a dynamic, rational expectations equilibrium model of asset prices where the drift of fundamentals (dividends) shifts between two unobservable states at random times. I show that in equilibrium, investors' willingness to hedge against changes in their own "uncertainty" on the true state makes stock prices overreact to bad news in good times and underreact to good news in bad times. I then show that this model is better able than conventional models with no regime shifts to explain features of stock returns, including volatility clustering, "leverage effects," excess volatility, and time-varying expected returns.
Reference Key
openalex_W2098347405 Use this key to autocite in the manuscript while using SciMatic Manuscript Manager or Thesis Manager
Authors Pietro Veronesi
Journal review of financial studies
Year 1999
DOI
10.1093/rfs/12.5.975
URL
https://doi.org/10.1093/rfs/12.5.975
Keywords Keywords not found

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