Abstract

http://ssrn.com/abstract=179670
 
 

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


Pietro Veronesi


University of Chicago - Booth School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)


Review of Financial Studies, Vol. 12, Issue 5, Winter 2000

Abstract:     
This paper 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.

JEL Classification: G12, G14

Accepted Paper Series


Not Available For Download

Date posted: March 28, 2000  

Suggested Citation

Veronesi, Pietro, Stock Market Overreaction to Bad News in Good Times: A Rational Expectations Equilibrium Model. Review of Financial Studies, Vol. 12, Issue 5, Winter 2000. Available at SSRN: http://ssrn.com/abstract=179670

Contact Information

Pietro Veronesi (Contact Author)
University of Chicago - Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-6348 (Phone)
773-702-0458 (Fax)
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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