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

Randolph B. Cohen; Christopher Polk; Tuomo Vuolteenaho

doi:10.1162/0033553053970133

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

Randolph B. Cohen^1,2; Christopher Polk³; Tuomo Vuolteenaho⁴

¹ Northwestern University · ² Harvard Business School · ³ Harvard University · ⁴ Littauer Center Cambridge, MA 02139 and NBER

Quarterly Journal of Economics 2005

Modigliani and Cohn 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 toward risk. Our empirical results support the hypothesis that the stock market suffers from money illusion.

DOI: 10.1162/0033553053970133
Volume: 120 (2)
Pages: 639-668
Language: en
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