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Empirical Rationality in the Stock Market

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  • Raahauge, Peter

    (Department of Finance, Copenhagen Business School)

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    Abstract

    This paper approximation errors are introduced in a Luca (1978)-type model to reflect model uncertainty. The purpose is twofold. First, the rational investor is allowed to take model uncertainty into account when asset prices are determined. Second, the statistical degeneracy, common to most structural models, is broken and maximum likehood inference made possible. The model is estimated using U.S. stock data. The equilibrium price is seriously affected by the existence of approximation errors and the descriptive and normative properties are greatly improved. This suggest that investors do not and should not ignore approximation errors.

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    File URL: http://openarchive.cbs.dk/cbsweb/handle/10398/7139
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    Bibliographic Info

    Paper provided by Copenhagen Business School, Department of Finance in its series Working Papers with number 2001-9.

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    Length: 29 pages
    Date of creation: 06 Dec 2001
    Date of revision:
    Handle: RePEc:hhs:cbsfin:2001_009

    Contact details of provider:
    Postal: Department of Finance, Copenhagen Business School, Solbjerg Plads 3, A5, DK-2000 Frederiksberg, Denmark
    Phone: +45 3815 3815
    Email:
    Web page: http://www.cbs.dk/departments/finance/
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    Related research

    Keywords: Approximation errors; rationality; structural estimation; risk premium; asset pricing;

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