Anchoring and Adjustment Heuristic: A Unified Explanation for Asset-Return Puzzles

I model a scenario in which investors do not know the payoff distributions of relatively newer firms and use the payoff distribution of similar well-established firms as starting points. The starting distributions are then adjusted for size, volatility, and other differences. Anchoring bias implies that such adjustments typically fall short. I show that incorporating such anchoring and adjustment heuristic into the standard consumption-based capital asset pricing model provides a unified explanation for 9 asset pricing puzzles including the equity premium puzzle. The anchoring approach achieves these explanations while maintaining the tractable framework of a representative agent with time-additive and isoelastic preferences in a complete market.


Issue Date:
2016-01
Publication Type:
Working or Discussion Paper
Record Identifier:
http://ageconsearch.umn.edu/record/229607
PURL Identifier:
http://purl.umn.edu/229607
Total Pages:
32
JEL Codes:
G02; G11; G12; D80; D81
Series Statement:
Finance
F16_1




 Record created 2017-04-01, last modified 2018-01-23

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