Anchoring Heuristic and the Equity Premium Puzzle

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

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.

• 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; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D80 - General; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D81 - Criteria for Decision-Making under Risk and Uncertainty; 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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