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Money Illusion in the Stock Market: The Modigliani-Cohn Hypothesis

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  • Randolph B. Cohen
  • Christopher Polk
  • Tuomo Vuolteenaho

Abstract

Modigliani and Cohn hypothesize that the stock market suffers from money illusion, discounting real cash flows at nominal discount rates. While previous research has focused on the pricing of the aggregate stock market relative to Treasury bills, the money-illusion hypothesis also has implications for the pricing of risky stocks relative to safe stocks. Simultaneously examining the pricing of Treasury bills, safe stocks, and risky stocks allows us to distinguish money illusion from any change in the attitudes of investors toward risk. Our empirical results support the hypothesis that the stock market suffers from money illusion. © 2005 MIT Press

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Bibliographic Info

Article provided by MIT Press in its journal The Quarterly Journal of Economics.

Volume (Year): 120 (2005)
Issue (Month): 2 (May)
Pages: 639-668

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Handle: RePEc:tpr:qjecon:v:120:y:2005:i:2:p:639-668

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  1. Stanley Fischer & Franco Modigliani, 1978. "Towards an understanding of the real effects and costs of inflation," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 114(4), pages 810-833, December.
  2. Christopher Polk & Paola Sapienza, 2004. "The Real Effects of Investor Sentiment," NBER Working Papers 10563, National Bureau of Economic Research, Inc.
  3. Vuolteenaho, Tuomo & Campbell, John, 2004. "Inflation Illusion and Stock Prices," Scholarly Articles 3196090, Harvard University Department of Economics.
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  8. Gibbons, Michael R & Ross, Stephen A & Shanken, Jay, 1989. "A Test of the Efficiency of a Given Portfolio," Econometrica, Econometric Society, vol. 57(5), pages 1121-52, September.
  9. Shleifer, Andrei & Vishny, Robert W, 1997. " The Limits of Arbitrage," Journal of Finance, American Finance Association, vol. 52(1), pages 35-55, March.
  10. Shleifer, Andrei & Vishny, Robert W, 1990. "Equilibrium Short Horizons of Investors and Firms," American Economic Review, American Economic Association, vol. 80(2), pages 148-53, May.
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