Working Paper Series, Department of Finance, Copenhagen Business School
Empirical Rationality in the Stock Market
Abstract: This paper approximation errors are introduced in a Luca
(1978)-type model to reflect model uncertainty. The purpose is twofold.
First, the rational investor is allowed to take model uncertainty into
account when asset prices are determined. Second, the statistical
degeneracy, common to most structural models, is broken and maximum
likehood inference made possible. The model is estimated using U.S. stock
data. The equilibrium price is seriously affected by the existence of
approximation errors and the descriptive and normative properties are
greatly improved. This suggest that investors do not and should not ignore
Keywords: Approximation errors; rationality; structural estimation; risk premium; asset pricing; (follow links to similar papers)
JEL-Codes: G10; G12; G19; (follow links to similar papers)
29 pages, December 6, 2001
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