Fluctuating Confidence in Stock Markets: Implications for Returns and Volatility

Journal of Financial and Quantitatve Analysis, December 1997

Posted: 18 Apr 1998

See all articles by Alexander David

Alexander David

Haskayne School of Business, University of Calgary

Abstract

The average relative profitability of different firms in the economy jumps erratically. Although investors are unable to observe these productivity switches, they continuously update their beliefs regarding high and low productivity firms by observing the total return on each firm, which consists of the average productivity plus noise. The portfolio choices, interest rate, and stock return processes are derived in a Cox-Ingersoll-Ross (1985a) style general equilibrium model. Three stylized facts of stock market returns are addressed: negative skewness, excess kurtosis, and predictive asymmetry (excess returns and future changes in volatility are negatively correlated). To measure the last stylized fact, an EGARCH model is fitted to sample paths simulated from the model. Parameter values that permit faster learning fit the three facts better.

JEL Classification: G12, G14

Suggested Citation

David, Alexander, Fluctuating Confidence in Stock Markets: Implications for Returns and Volatility. Journal of Financial and Quantitatve Analysis, December 1997, Available at SSRN: https://ssrn.com/abstract=45213

Alexander David (Contact Author)

Haskayne School of Business, University of Calgary ( email )

2500 University Drive NW
Calgary, Alberta T2N1N4
Canada
403-220-6987 (Phone)

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