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- Publisher
- Oxford University Press
- Copyright
- © 1999 The Society for Financial Studies
- ISSN
- 0893-9454
- eISSN
- 1465-7368
- DOI
- 10.1093/rfs/12.5.975
- Publisher site
- See Article on Publisher Site
Abstract
This article 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.
Journal
The Review of Financial Studies – Oxford University Press
Published: Oct 1, 1999