The Investor Recognition Hypothesis in a Dynamic General Equilibrium: Theory and Evidence

50 Pages Posted: 12 Nov 2008

See all articles by Alex Shapiro

Alex Shapiro

New York University (NYU) - Department of Finance

Multiple version iconThere are 3 versions of this paper

Date Written: September 1999

Abstract

This paper analyzes equilibrium in a dynamic pure-exchange economy under a generalization of Merton's (1987) investor recognition hypothesis (IRH). Because of information costs, a class of investors is assumed to possess incomplete information, which suffices to implement only a particular trading strategy. The IRH is mapped into corresponding portfolio restrictions that bind a subset of agents. The model is formulated in continuous time, and detailed characterization of equilibrium quantities is provided. The model implies that, all else equal, a risk premium on a less visible stock need not be higher than that on a more visible stock with a lower volatility -- contrary to results derived in a static mean-variance setting. An empirical analysis suggests that a consumption-based capital asset pricing model (CCAPM) augmented by the IRH is a more realistic model than the traditional CCAPM for explaining the cross-sectional variation in unconditional expected equity returns.

Suggested Citation

Shapiro, Alex, The Investor Recognition Hypothesis in a Dynamic General Equilibrium: Theory and Evidence (September 1999). NYU Working Paper No. S-MF-99-11. Available at SSRN: https://ssrn.com/abstract=1300263

Alex Shapiro (Contact Author)

New York University (NYU) - Department of Finance ( email )

Stern School of Business
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New York, NY 10012-1126
United States
212-998-0362 (Phone)
212-995-4233 (Fax)

HOME PAGE: http://www.stern.nyu.edu/~ashapiro/

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