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

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  • Siddiqi, Hammad

Abstract

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.

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  • Siddiqi, Hammad, 2016. "Anchoring and Adjustment Heuristic: A Unified Explanation for Asset-Return Puzzles," Risk and Sustainable Management Group Working Papers 229607, University of Queensland, School of Economics.
    • Handle: RePEc:ags:uqsers:229607
    DOI: 10.22004/ag.econ.229607
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