Compounding Money and Nominal Price Illusions

Mustafa O. Caglayan (), Diogo Duarte (), Victor F. Duarte () and Xiaomeng Lu ()
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Mustafa O. Caglayan: College of Business, Florida International University, Miami, Florida 33199
Diogo Duarte: College of Business, Florida International University, Miami, Florida 33199
Victor F. Duarte: Gies College of Business, University of Illinois Urbana-Champaign, Champaign, Illinois 61820
Xiaomeng Lu: College of Business and Technology, Georgia College & State University, Milledgeville, Georgia 31061

Management Science, 2025, vol. 71, issue 6, 5204-5229

Abstract: We develop a general equilibrium model in which investors simultaneously experience money and nominal price illusions. We show that the combined effects of these illusions widen the gap between the elasticities of the earnings yield of low- and high-priced stocks relative to the nominal interest rate. Empirically, we show that the compounded effects of money and nominal price illusions are stronger for low-priced stocks during periods of high inflation and economic downturns and for stocks with low institutional ownership. Our findings are robust when controlling for valuation uncertainties of low-priced stocks, including idiosyncratic volatility and firm age.

Keywords: money illusion; nominal price illusion; inflation; Fed model (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:71:y:2025:i:6:p:5204-5229

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