D8 - Information, Knowledge, and Uncertainty

• Are Distorted Beliefs Too Good to be True?

  Staff Working Paper 2003-4 Miroslav Misina

  In a recent attempt to account for the equity-premium puzzle within a representative-agent model, Cecchetti, Lam, and Mark (2000) relax the assumption of rational expectations and in its place use the assumption of distorted beliefs. The author shows that the explanatory power of the distorted beliefs model is due to an inconsistency in the model and that an attempt to remove this inconsistency removes the model's explanatory power.

  Content Type(s): Staff research, Staff working papers Topic(s): Economic models, Financial markets JEL Code(s): D, D8, D84, G, G1, G12

• Risk, Entropy, and the Transformation of Distributions

  Staff Working Paper 2002-11 Mark Reesor, Don McLeish

  The exponential family, relative entropy, and distortion are methods of transforming probability distributions. We establish a link between those methods, focusing on the relation between relative entropy and distortion.

  Content Type(s): Staff research, Staff working papers Topic(s): Econometric and statistical methods, Financial markets, Market structure and pricing JEL Code(s): C, C0, C1, D, D8, G, G0