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Money Illusion in the Stock Market: The Modigliani-Cohn Hypothesis

39 Pages Posted: 12 Jan 2005 Last revised: 11 Aug 2010

Randolph B. Cohen

Harvard Business School - Finance Unit

Christopher Polk

London School of Economics

Tuomo Vuolteenaho

Arrowstreet Capital, LP; National Bureau of Economic Research (NBER)

Date Written: January 2005

Abstract

Modigliani and Cohn [1979] hypothesize that the stock market suffers from money illusion, discounting real cash flows at nominal discount rates. While previous research has focused on the pricing of the aggregate stock market relative to Treasury bills, the money-illusion hypothesis also has implications for the pricing of risky stocks relative to safe stocks. Simultaneously examining the pricing of Treasury bills, safe stocks, and risky stocks allows us to distinguish money illusion from any change in the attitudes of investors towards risk. Our empirical resuts support the hypothesis that the stock market suffers from money illusion.

Suggested Citation

Cohen, Randolph B. and Polk, Christopher and Vuolteenaho, Tuomo, Money Illusion in the Stock Market: The Modigliani-Cohn Hypothesis (January 2005). NBER Working Paper No. w11018. Available at SSRN: https://ssrn.com/abstract=647384

Randolph B. Cohen

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-6674 (Phone)
617-496-6592 (Fax)

Christopher Polk

London School of Economics ( email )

United Kingdom

HOME PAGE: http://personal.lse.ac.uk/polk/

Tuomo Vuolteenaho (Contact Author)

Arrowstreet Capital, LP ( email )

44 Brattle St., 5th Floor
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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