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Empirical Rationality in the Stock Market

  • Raahauge, Peter

    (Department of Finance, Copenhagen Business School)

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    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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    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
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