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Fluctuating Confidence in Stock Markets: Implications for Returns and Volatility

Published online by Cambridge University Press:  06 April 2009

Alexander David
Alexander David
Affiliation:
Division of Research and Statistics, Board of Governors of the Federal Reserve System, Washington, D.C. 20551.
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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.

Information

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 32 , Issue 4 , December 1997 , pp. 427 - 462
Copyright
Copyright © School of Business Administration, University of Washington 1997

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