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Anchoring and Adjustment Heuristic: A Unified Explanation for Equity 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, 2015. "Anchoring and Adjustment Heuristic: A Unified Explanation for Equity Puzzles," MPRA Paper 68729, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:68729
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    More about this item

    Keywords

    The Equity Premium Puzzle; Anchoring Bias; The Risk-Free Rate Puzzle; Countercyclical Equity Premium; Stock Price Volatility; Knightian Uncertainty;
    All these keywords.

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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