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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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Abstract

What happens when the anchoring and adjustment heuristic of Tversky and Kahneman (1974) is incorporated in the standard consumption-based capital asset pricing model (CCAPM)? The surprising finding is that it not only resolves the high equity-premium and low risk-free rate puzzles with a low risk-aversion coefficient, but also provides a unified framework for understanding countercyclical equity-premium, excess volatility, size, value, and momentum effects, and abnormal returns and volatilities following stock-splits and reverse stock-splits. The anchoring approach makes the following prediction: equity in firms with less volatile earnings would outperform equity in firms with more volatile earnings.

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