SURVEYS AND CROSSOVERS: Bayesian Modeling in Finance
Xiaojing Dong and Carrie H. Pan
Volume 11, Number 1, First Quarter 2013
The Bayesian statistical method provides an alternative approach to study some of the classical problems in finance. In the existing finance literature, research that uses Bayesian econometrics is primarily in the area of asset pricing. Bayesian applications in corporate finance have been rather limited, despite its great potential as a viable alternative to address some challenging problems in corporate finance that are difficult to solve by the traditional approach. Bayesian estimation techniques, the Markov Chain Monte Carlo (MCMC) methods in particular, are very conductive to estimating nonlinear models with high dimensional integrals in the likelihood or models with a hierarchical structure. In this paper, we outline the basic concepts of Bayesian modeling, describe most commonly used estimation techniques, and review its applications in the existing finance literature.