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Are Distorted Beliefs Too Good to be True?

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  • Miroslav Misina

Abstract

In a recent attempt to account for the equity-premium puzzle within a representative-agent model, Cecchetti, Lam, and Mark (2000) relax the assumption of rational expectations and in its place use the assumption of distorted beliefs. The author shows that the explanatory power of the distorted beliefs model is due to an inconsistency in the model and that an attempt to remove this inconsistency removes the model’s explanatory power. Using the theory of rational beliefs, the author constructs a model in which the inconsistency is not present, compares its performance with that of the distorted beliefs model, and gives a simple interpretation of the results obtained.

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File URL: http://www.bankofcanada.ca/wp-content/uploads/2010/02/wp03-4.pdf
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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 03-4.

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Length: 43 pages
Date of creation: 2003
Date of revision:
Handle: RePEc:bca:bocawp:03-4

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Keywords: Economic models; Financial markets;

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  1. Francis Vitek, 2002. "An Empirical Analysis of Dynamic Interrelationships Among Inflation, Inflation Uncertainty, Relative Price Dispersion, and Output Growth," Working Papers 02-39, Bank of Canada.
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Cited by:
  1. Miroslav Misina, 2005. "Risk Perceptions and Attitudes," Working Papers 05-17, Bank of Canada.
  2. Miroslav Misina, 2003. "What Does the Risk-Appetite Index Measure?," Working Papers 03-23, Bank of Canada.
  3. Misina, Miroslav, 2006. "Equity premium with distorted beliefs: A puzzle," Journal of Economic Dynamics and Control, Elsevier, vol. 30(8), pages 1431-1440, August.

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