A new pseudo-Bayesian model with implications for financial anomalies and investors' behavior

Kin Lam, Taisheng Liu, Wing Keung WONG*

*Corresponding author for this work

    Research output: Contribution to journalJournal articlepeer-review

    37 Citations (Scopus)

    Abstract

    Barberis, Shleifer, and Vishny [1998] and others have developed Bayesian models to explain investors' behavioral biases by using conservative heuristics and representative 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 a theory to explain some market anomalies, including short-term underreaction, long-term overreaction, and excess volatility. We also explain in detail the linkage between these market anomalies and investors' behavioral biases.

    Original languageEnglish
    Pages (from-to)93-107
    Number of pages15
    JournalJournal of Behavioral Finance
    Volume13
    Issue number2
    DOIs
    Publication statusPublished - 2012

    Scopus Subject Areas

    • Experimental and Cognitive Psychology
    • Finance

    User-Defined Keywords

    • Bayesian model
    • Overreaction
    • Representative and conservative heuristics
    • Stock price
    • Stock return
    • Underreaction

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