This study attempts to link psychological research, empirical evidence, and asset-pricing theory to examine how investor sentiment affects financial market volatility. We provide insight into that question by exploring different parameter configurations using the general equilibrium model of Lucas [1978]. The Lucas model is the most influential asset-pricing model and has been of central importance to modern macroeconomics. Traditional economic analyses are based on the efficient markets hypothesis (EMH), which assumes that people price assets by measuring probability and using all available information, and hence leave little room for investor sentiment. As behavior is motivated by both thoughts and feelings, considering investor sentiment …show more content…
The most basic application of the Lucas model is to price equity in an economy with i.i.d. consumption growth and a representative infinitely lived and intertemporally maximizing consumer with time-separable utility. Over the past decades, numerous studies have investigated the effects of relaxing various assumptions of this model to explain financial market phenomena such as the remarkable variation in asset prices and expected stock returns, the development and bursting of bubbles, and the puzzling high equity premium. Mehra and Sah [2002] suggested that elasticity offers a simple but powerful representation of the influence of fluctuations in the denominator variable on the volatility of the numerator variable. More importantly, elasticity is unit-free, and thus can be considered a convenient measurement that captures sentiment induced fluctuations in financial markets. This section derives the elasticity of both equity and bill prices with respect to sentiment factors to explore the effect of sentiment fluctuations on asset price volatility. First, sentiment variations significantly influence equity price volatility. Second, both sentiment factors affect equity price volatility more than bill price volatility because the elasticity of equity prices to both sentiment factors exceeds that of bill prices. Third psychological research suggests that positive sentiment generally guides people to underestimate risk or take more risk. Fourth, the influence of sentiment fluctuations on equity price volatility is stronger when investors are less risk averse and more patient. The above analyses reveal that varying sentiment factors significantly influence price volatility for both assets. Shifting sentiment factors that influence equity and bill prices may also affect the expected returns of both assets.
Price elasticity of supply can have multiple effects on a market based on the amount of time needed to react to a price change. There are 3 time categories to describe how mush the
9. How should William advise Mary Swanson? Most importantly, should William advise Swanson to shift a large percentage of her portfolio funds from equities to corporate bonds? Mary Swanson is a retired professor with a portfolio of more than 1 Million and she is a non-emotional decision maker meaning that she was affected by the news, but not as much as other clients like Bob Miller. She didn’t have any short-term liquid constraints and her investment horizon was 30 years and need of growth.
Filled with prosperity and growth, everyone thought the twenties were the start of a great run for the United States. Dr. Dice, a business professor at Ohio State University, predicted that the stock market would continue to gain in the near future, more than ever before (Document 6). But, he went on to say that it would eventually collapse. Not only did he know that it cannot continue to grow forever, but he realized that small investors have begun to take part in the game of stock. He saw that such investors would add to the vulnerability of the market.
I am amused by the answers provided here. The most amazing thing is no one have any idea about how economics work. I am not an economics expert, but this is the probably first thing you'll be taught in economics after demand/supply curve. Currency prices works like an index of prosperity in the respective nation.
However, the “steadily rising price of stocks” on the Wall Street stock market attracted more investors (Give Me Liberty, Eric Foner, pg 786). “Many assumed that
For instance, buyers started generating more income or more volume of money, thus there will be high demand and the price of the goods or services will be increased. Another example is, during pick season (vocation period), air-tickets cost higher because demand for trips or recreation is needed
Outline the similarities and differences between the Single Index Model (SIM) and the Capital Asset Pricing Model (CAPM). Justify which of the two models makes a better assessment of return of a security (25 marks). To reduce a firm’s specific risk or residual risk a portfolio should have negative covariance or rather it should have no variance at all, for large portfolios however calculating variance requires greater and sophisticated computing power. As such, Index models greatly decrease the computations needed to calculate the optimum portfolio. The use of such Index models also eliminates illogical or rather absurd results.
1. What are three economic stances that a government may have? Describe each of these stances. Answer:
Frederick MacCauley documented that fluctuations of the stock market is analogous to the chance curve that could be obtained by throwing a dice (MacCauley, 1925). Oliver (1926) and Mills (1927) provided evidence that the distribution of stock returns is leptokurtic in nature. Random movement and inability to predict stocks prices is found in a number of studies during 1920s and 1930s. Cowles (1933) analyzed stock price prediction made by the 45 representatives of financial agencies during 1928 to 1932 and found that forecasters cannot forecast movement of stock markets. Working (1934) mentioned that stock return behaved like a number in the lottery.
As you can see the demand for a good is tied to the price of that good and the demand
Nassim Taleb's book ‘Fooled by Randomness’, explores many themes and concepts of randomness and probability in the business world. The main point that Taleb argues is that chance plays a dominant role in many aspects of our daily life, including financial markets, and that to succeed in life the role of chance must be understood, so that a person can maximise their gains and minimise their losses. In his book Taleb aimed to encourage his readers to clearly see the illusions of skill in their lives and recognise that the patterns that behaviours are commonly based on are merely random outcomes interpreted with biases. In several incidences, Taleb uses examples from the gambling literature to explain the role of chance, probability and perceptual biases, most frequently in
Fiscal policy is a policy in which government adjusts its spending levels and tax rates to monitor and influence a nation’s economy. In Economics Today: The Macro View, fiscal policy is defined as “The discretionary changing of government expenditures or taxes to achieve national economic goals, such as high employment with price stability” (Miller, 2012, p. 278). This policy not only directs the overall economy, but suggests the urgencies of individual lawmakers. Furthermore, through this policy, regulators will attempt to control inflation, stabilize business cycles, improve unemployment rates, and influence interest rates in an effort to regulate the economy. Bearing in mind an economy is facing a recession, the government may lower the
1929 economic crisis, which is generally called as Great Depression, had upset the balance of world economic order. Until the depression, classical liberal economic theories were dominating World order. Classical economics is a supply oriented theory, claiming that whatever the level of supply, it is going to create its own demand in the market. If the free market determines the levels of prices, economy will always be in the situation of full employment. Accordingly, states should never interfere in the market.
With the recent complicated economic financial environments, there may be some abnormal relationships comparing with the theories. We cannot examine them in the project. 3.
Outline the similarities and differences between the Single Index Model (SIM) and the Capital Asset Pricing Model (CAPM). Justify which of the two models makes a better assessment of return of a security (25 marks). To reduce a firm’s specific risk or residual risk a portfolio should have negative covariance or rather it should have no variance at all, for large portfolios however calculating variance requires greater and sophisticated computing power. As such, Index models greatly decrease the computations needed to calculate the optimum portfolio. The use of such Index models also eliminates illogical or rather absurd results.