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Empirical Rationality in the Stock Market

Author

Listed:
  • Raahauge, Peter

    (Department of Finance, Copenhagen Business School)

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.

Suggested Citation

  • Raahauge, Peter, 2001. "Empirical Rationality in the Stock Market," Working Papers 2001-9, Copenhagen Business School, Department of Finance.
    • Handle: RePEc:hhs:cbsfin:2001_009
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    File URL: http://openarchive.cbs.dk/cbsweb/handle/10398/7139
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    More about this item

    Keywords

    Approximation errors; rationality; structural estimation; risk premium; asset pricing;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G19 - Financial Economics - - General Financial Markets - - - Other

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