A New Pseudo-Bayesian Model with Implications to Financial Anomalies and Investors’ Behaviors

41 Pages Posted: 19 May 2010 Last revised: 21 Dec 2010

See all articles by Kin Lam

Kin Lam

Hong Kong Baptist University (HKBU)

Taisheng

Hong Kong Baptist University (HKBU)

Wing-Keung Wong

Asia University, Department of Finance

Date Written: December 12, 2010

Abstract

Barberis, Shleifer and Vishny (1998) and others have developed Bayesian models to explain investors’ behavioral biases by using the conservatism heuristics and the representativeness heuristics in making decisions. To extend their work, Lam, Liu, and Wong (2010) have developed 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. This paper extends their work further by developing properties to explain some market anomalies including short-term underreaction, long-term overreaction, and excess volatility. We also explain in details the linkage between these market anomalies and investors’ behavioral biases.

Keywords: Bayesian model, Representative and conservative heuristics, Underreaction, Overreaction, Stock price, Stock return

Suggested Citation

Lam, Kin and Liu, Taisheng and Wong, Wing-Keung, A New Pseudo-Bayesian Model with Implications to Financial Anomalies and Investors’ Behaviors (December 12, 2010). Available at SSRN: https://ssrn.com/abstract=1611648 or http://dx.doi.org/10.2139/ssrn.1611648

Kin Lam

Hong Kong Baptist University (HKBU) ( email )

Department of Finance and Decision Sciences Renfrew Road
Kowloon
HONG KONG
00 852 2339 5007 (Phone)
00 852 2339 5585 (Fax)

Taisheng Liu

Hong Kong Baptist University (HKBU) ( email )

Department of Economics
Kowloon, Hong Kong
Hong Kong

Wing-Keung Wong (Contact Author)

Asia University, Department of Finance ( email )

Taiwan
Taiwan

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