A Bayesian Approach to Explain Excess Volatility, Short-Term Underreaction, and Long-Term Overreaction During Normal Situations and Financial Crises

In this paper, we introduce a new Bayesian approach to explain some market anomalies. We first develop some properties on the expected earnings shock and its volatility and establish some properties of investors' behavior on the stock price and its volatility during a financial crisis and subsequent recovery. Thereafter, we develop properties to explain excess volatility, short-term underreaction, long-term overreaction, and their magnitude effects during a normal financial situation as well as during a financial crisis and subsequent recovery