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Asset Mispricing Due to Cognitive Dissonance

  • Bernhard Eckwert
  • Burkhard Drees

The behavior of equity prices is analyzed in a general equilibrium model where agents have preferences not only over consumption but also (implicitly) over their beliefs. To alleviate cognitive dissonance, investors endogenously choose to ignore information that conflicts too much with their ex ante expectations. Depending on the new information that is released, systematic overvaluation and undervaluation of equity prices arise, as well as too much and too little equity price volatility. The distortion in the asset pricing process is closely related to the precision of the information.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 05/9.

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Length: 30
Date of creation: 01 Jan 2005
Date of revision:
Handle: RePEc:imf:imfwpa:05/9
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