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Anchoring Heuristic and the Equity Premium Puzzle

Siddiqi, Hammad (2015): Anchoring Heuristic and the Equity Premium Puzzle.

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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 (Tversky and Kahneman (1974)) implies that such adjustments typically fall short. I show that adjusting consumption CAPM for anchoring 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 preferences in a complete market.

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