Asset Pricing in the Resource-Constrained Brain

Hammad Siddiqi

MPRA Paper from University Library of Munich, Germany

Abstract: Despite scarcity being central to economics, the scarcity of brain’s internal resources has largely been ignored. Neuroscience research increasingly points to the brain evolving as a prediction engine in response to this internal-resource scarcity. The brain meets every situation with subconscious expectations, which are contrasted with information to generate error-signals. Selective processing of such error-signals, in lieu of the entire information-stream, saves brain-resources. We show that applying this predictive-processing framework to asset pricing gives rise to an alpha in CAPM. Several empirically observed phenomena (value, momentum, size, high-alpha-of-low-beta, profitability, investment, and time-specific changes in SML slopes) correspond to either cross-sectional or time-specific variations in this alpha. Additional insights about these phenomena emerge that are consistent with empirical evidence. Hence, potentially, a unified explanation for several asset pricing anomalies emerges as ultimately due to the brain’s optimal response to its own internal resource scarcity, suggesting a synthesis of neoclassical and behavioral finance.

Keywords: Predictive Processing; Asset Pricing; CAPM; SML Slope; Betting-Against-Beta; Size Effect; Value Effect; Momentum Effect (search for similar items in EconPapers)
JEL-codes: G11 G12 (search for similar items in EconPapers)
Date: 2022-04-05, Revised 2024-02-05
New Economics Papers: this item is included in nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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https://mpra.ub.uni-muenchen.de/120742/1/MPRA_paper_120742.pdf revised version (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:120526

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