Anchoring and Adjustment Heuristic: A Unified Explanation for Asset-Return Puzzles

26 Pages Posted: 11 Jan 2016 Last revised: 25 Feb 2017

See all articles by Hammad Siddiqi

Hammad Siddiqi

University of the Sunshine Coast-School of Business

Date Written: October 1, 2016

Abstract

Decision-makers typically rely on informative starting points that are somewhat incorrect and then attempt to make appropriate adjustments. Such reliance on informative starting points may be an optimal response of a Bayesian decision-maker who faces finite computational resources (Lieder et al 2013). Professional equity-analysts take the same approach when they co-categorize closely related firms in peer-groups and routinely extrapolate the analysis pertaining to a prominent firm to other firms in the same peer-group. We show that if the representative agent behaves like a professional equity analyst, then a unified explanation for 5 asset-market phenomena emerges. The phenomena explained include high and counter-cyclical equity premium, size effect, value premium, and media-coverage effect. A novel prediction of the model is that stocks with less volatile payoffs outperform stocks with more volatile payoffs. Empirical evidence strongly supports this prediction.

Keywords: The Equity Premium Puzzle, Anchoring Bias, The Risk-Free Rate Puzzle, Countercyclical Equity Premium, Stock Price Volatility, Knightian Uncertainty

JEL Classification: G02, G11, G12, D80, D81

Suggested Citation

Siddiqi, Hammad, Anchoring and Adjustment Heuristic: A Unified Explanation for Asset-Return Puzzles (October 1, 2016). Available at SSRN: https://ssrn.com/abstract=2712992 or http://dx.doi.org/10.2139/ssrn.2712992

Hammad Siddiqi (Contact Author)

University of the Sunshine Coast-School of Business ( email )

Brisbane, QLD 70010
Australia
+61404900497 (Phone)

HOME PAGE: http://www.usc.edu.au/staff-repository/dr-hammad-siddiqi

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