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Compounding Money and Nominal Price Illusions

Author

Listed:
  • Mustafa O. Caglayan

    (College of Business, Florida International University, Miami, Florida 33199)

  • Diogo Duarte

    (College of Business, Florida International University, Miami, Florida 33199)

  • Victor F. Duarte

    (Gies College of Business, University of Illinois Urbana-Champaign, Champaign, Illinois 61820)

  • Xiaomeng Lu

    (College of Business and Technology, Georgia College & State University, Milledgeville, Georgia 31061)

Abstract

We develop a general equilibrium model in which investors simultaneously experience money and nominal price illusions. We show that the combined effects of these illusions widen the gap between the elasticities of the earnings yield of low- and high-priced stocks relative to the nominal interest rate. Empirically, we show that the compounded effects of money and nominal price illusions are stronger for low-priced stocks during periods of high inflation and economic downturns and for stocks with low institutional ownership. Our findings are robust when controlling for valuation uncertainties of low-priced stocks, including idiosyncratic volatility and firm age.

Suggested Citation

  • Mustafa O. Caglayan & Diogo Duarte & Victor F. Duarte & Xiaomeng Lu, 2025. "Compounding Money and Nominal Price Illusions," Management Science, INFORMS, vol. 71(6), pages 5204-5229, June.
    • Handle: RePEc:inm:ormnsc:v:71:y:2025:i:6:p:5204-5229
    DOI: 10.1287/mnsc.2023.03549
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