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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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Web page: http://mitpress.mit.edu/journals/

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  7. Jeremy C. Stein, 1996. "Rational Capital Budgeting in an Irrational World," NBER Working Papers 5496, National Bureau of Economic Research, Inc.
  8. 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.
  9. French, Kenneth R & Ruback, Richard S & Schwert, G William, 1983. "Effects of Nominal Contracting on Stock Returns," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 70-96, February.
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