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Money Illusion in the Stock Market: The Modigliani-Cohn Hypothesis

  • Randolph B. Cohen
  • Christopher Polk
  • Tuomo Vuolteenaho

Modigliani and Cohn hypothesize that the stock market suffers from money illusion, discounting real cash flows at nominal discount rates. While previous research has focused on the pricing of the aggregate stock market relative to Treasury bills, the money-illusion hypothesis also has implications for the pricing of risky stocks relative to safe stocks. Simultaneously examining the pricing of Treasury bills, safe stocks, and risky stocks allows us to distinguish money illusion from any change in the attitudes of investors toward risk. Our empirical results support the hypothesis that the stock market suffers from money illusion. © 2005 MIT Press

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Article provided by MIT Press in its journal The Quarterly Journal of Economics.

Volume (Year): 120 (2005)
Issue (Month): 2 (May)
Pages: 639-668

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Handle: RePEc:tpr:qjecon:v:120:y:2005:i:2:p:639-668
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  1. Vuolteenaho, Tuomo & Campbell, John, 2004. "Inflation Illusion and Stock Prices," Scholarly Articles 3196090, Harvard University Department of Economics.
  2. Stein, Jeremy C., 1996. "Rational Capital Budgeting in an Irrational World," Scholarly Articles 3708373, Harvard University Department of Economics.
  3. Stanley Fischer & Franco Modigliani, 1978. "Towards an understanding of the real effects and costs of inflation," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 114(4), pages 810-833, December.
  4. K.C. Chan & Patric H. Hendershott & Anthony B. Sanders, 1990. "Risk and Return on Real Estate: Evidence from Equity REITs," NBER Working Papers 3311, National Bureau of Economic Research, Inc.
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  7. French, Kenneth R & Ruback, Richard S & Schwert, G William, 1983. "Effects of Nominal Contracting on Stock Returns," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 70-96, February.
  8. Fama, Eugene F & French, Kenneth R, 1992. " The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-65, June.
  9. Polk, Christopher & Sapienza, Paola, 2003. "The Real Effects of Investor Sentiment," CEPR Discussion Papers 3826, C.E.P.R. Discussion Papers.
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