Anchoring and Adjustment Heuristic: A Unified Explanation for Equity Puzzles

Siddiqi, Hammad (2015): Anchoring and Adjustment Heuristic: A Unified Explanation for Equity Puzzles.

Abstract

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 implies that such adjustments typically fall short. I show that incorporating such anchoring and adjustment heuristic into the standard consumption-based capital asset pricing model 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 and isoelastic preferences in a complete market.

• Item Type: MPRA Paper
• Language: English
• Keywords: The Equity Premium Puzzle, Anchoring Bias, The Risk-Free Rate Puzzle, Countercyclical Equity Premium, Stock Price Volatility, Knightian Uncertainty
• Subjects: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D84 - Expectations ; Speculations; G - Financial Economics > G0 - General > G02 - Behavioral Finance: Underlying Principles; G - Financial Economics > G1 - General Financial Markets > G10 - General; G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates

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