IDEAS home Printed from https://ideas.repec.org/p/pra/mprapa/120526.html
   My bibliography  Save this paper

Asset Pricing in the Resource-Constrained Brain

Author

Listed:
  • Siddiqi, Hammad

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.

Suggested Citation

  • Siddiqi, Hammad, 2022. "Asset Pricing in the Resource-Constrained Brain," MPRA Paper 120526, University Library of Munich, Germany, revised 05 Feb 2024.
    • Handle: RePEc:pra:mprapa:120526
    as

    Download full text from publisher

    File URL: https://mpra.ub.uni-muenchen.de/120526/1/MPRA_paper_120526.pdf
    File Function: original version
    Download Restriction: no
    File URL: https://mpra.ub.uni-muenchen.de/120742/1/MPRA_paper_120742.pdf
    File Function: revised version
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Hammad Siddiqi, 2018. "Anchoring-Adjusted Capital Asset Pricing Model," Journal of Behavioral Finance, Taylor & Francis Journals, vol. 19(3), pages 249-270, July.
    2. Hammad Siddiqi & John Quiggin, 2019. "The pricing kernel puzzle: A behavioral explanation," Cogent Economics & Finance, Taylor & Francis Journals, vol. 7(1), pages 1684609-168, January.
    3. Ricardo Alonso & Isabelle Brocas & Juan D. Carrillo, 2014. "Resource Allocation in the Brain," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 81(2), pages 501-534.
    4. John Y. Campbell & Stefano Giglio & Christopher Polk, 2023. "What Drives Booms and Busts in Value?," NBER Working Papers 31859, National Bureau of Economic Research, Inc.
    5. Asness, Clifford & Frazzini, Andrea & Israel, Ronen & Moskowitz, Tobias J. & Pedersen, Lasse H., 2018. "Size matters, if you control your junk," Journal of Financial Economics, Elsevier, vol. 129(3), pages 479-509.
    6. Simon Huang, 2022. "The Momentum Gap and Return Predictability," The Review of Financial Studies, Society for Financial Studies, vol. 35(7), pages 3303-3336.
    7. Fama, Eugene F. & French, Kenneth R., 2015. "A five-factor asset pricing model," Journal of Financial Economics, Elsevier, vol. 116(1), pages 1-22.
    8. Jieting Chen & Yuichiro Kawaguchi, 2018. "A Revisit of the Cross-Section of Overnight and Intraday Abnormal Returns: Evidence from the Japanese REIT Market," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 10(1), pages 46-63, January.
    9. Matthias M M Buehlmaier & Toni M Whited, 2018. "Are Financial Constraints Priced? Evidence from Textual Analysis," The Review of Financial Studies, Society for Financial Studies, vol. 31(7), pages 2693-2728.
    10. Avramov, Doron & Cheng, Si & Hameed, Allaudeen, 2016. "Time-Varying Liquidity and Momentum Profits," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 51(6), pages 1897-1923, December.
    11. Savor, Pavel & Wilson, Mungo, 2014. "Asset pricing: A tale of two days," Journal of Financial Economics, Elsevier, vol. 113(2), pages 171-201.
    12. Baruch Lev & Srivastava Anup, 2022. "Explaining the Recent Failure of Value Investing," Critical Finance Review, now publishers, vol. 11(2), pages 333-360, May.
    13. Yu, Hsin-Yi & Chen, Li-Wen & Chen, Chang-Yi, 2022. "The profitability effect: An evaluation of alternative explanations," Pacific-Basin Finance Journal, Elsevier, vol. 72(C).
    14. Jegadeesh, Narasimhan & Titman, Sheridan, 1993. "Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency," Journal of Finance, American Finance Association, vol. 48(1), pages 65-91, March.
    15. Stoll, Hans R. & Whaley, Robert E., 1983. "Transaction costs and the small firm effect," Journal of Financial Economics, Elsevier, vol. 12(1), pages 57-79, June.
    16. Lou, Dong & Polk, Christopher & Skouras, Spyros, 2019. "A tug of war: overnight versus intraday expected returns," LSE Research Online Documents on Economics 87481, London School of Economics and Political Science, LSE Library.
    17. Lou, Dong & Polk, Christopher & Skouras, Spyros, 2019. "A tug of war: Overnight versus intraday expected returns," Journal of Financial Economics, Elsevier, vol. 134(1), pages 192-213.
    18. Randolph B. Cohen & Christopher Polk & Tuomo Vuolteenaho, 2005. "Money Illusion in the Stock Market: The Modigliani-Cohn Hypothesis," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 120(2), pages 639-668.
    19. Hammad Siddiqi & Austin Murphy, 2023. "The Resource-Constrained Brain: A New Perspective on the Equity Premium Puzzle," Journal of Behavioral Finance, Taylor & Francis Journals, vol. 24(3), pages 315-332, July.
    20. Hendershott, Terrence & Livdan, Dmitry & Rösch, Dominik, 2020. "Asset pricing: A tale of night and day," Journal of Financial Economics, Elsevier, vol. 138(3), pages 635-662.
    21. Richard B. McKenzie, 2018. "A Brain-Focused Foundation for Economic Science," Springer Books, Springer, number 978-3-319-76810-6, October.
    22. Bogousslavsky, Vincent, 2021. "The cross-section of intraday and overnight returns," Journal of Financial Economics, Elsevier, vol. 141(1), pages 172-194.
    23. Eugene F. Fama & Kenneth R. French, 2016. "Dissecting Anomalies with a Five-Factor Model," The Review of Financial Studies, Society for Financial Studies, vol. 29(1), pages 69-103.
    24. Eugene F. Fama & Kenneth R. French, 2004. "The Capital Asset Pricing Model: Theory and Evidence," Journal of Economic Perspectives, American Economic Association, vol. 18(3), pages 25-46, Summer.
    25. Siddiqi, Hammad, 2017. "Certain and uncertain utility: A new perspective on financial innovation," Economics Letters, Elsevier, vol. 158(C), pages 7-9.
    26. Hammad Siddiqi, 2019. "Anchoring-Adjusted Option Pricing Models," Journal of Behavioral Finance, Taylor & Francis Journals, vol. 20(2), pages 139-153, April.
    27. Black, Fischer, 1972. "Capital Market Equilibrium with Restricted Borrowing," The Journal of Business, University of Chicago Press, vol. 45(3), pages 444-455, July.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Hammad, Siddiqi & Austin, Murphy, 2020. "Optimal Resource Allocation in the Brain and the Capital Asset Pricing Model," MPRA Paper 102705, University Library of Munich, Germany.
    2. Chan, Kam Fong & Marsh, Terry, 2022. "Asset pricing on earnings announcement days," Journal of Financial Economics, Elsevier, vol. 144(3), pages 1022-1042.
    3. Siddiqi, Hammad, 2019. "CAPM: A Tale of Two Versions," MPRA Paper 92798, University Library of Munich, Germany.
    4. Hendershott, Terrence & Livdan, Dmitry & Rösch, Dominik, 2020. "Asset pricing: A tale of night and day," Journal of Financial Economics, Elsevier, vol. 138(3), pages 635-662.
    5. Insana, Alessandra, 2023. "Betting against beta with intraday and overnight signals," International Review of Financial Analysis, Elsevier, vol. 86(C).
    6. Bogousslavsky, Vincent, 2021. "The cross-section of intraday and overnight returns," Journal of Financial Economics, Elsevier, vol. 141(1), pages 172-194.
    7. Michael Hasler & Charles Martineau, 2023. "Explaining the Failure of the Unconditional CAPM with the Conditional CAPM," Management Science, INFORMS, vol. 69(3), pages 1835-1855, March.
    8. Kaserer Christoph & Hanauer Matthias X., 2017. "25 Jahre Fama-French-Modell: Erklärungsgehalt, Anomalien und praktische Implikationen," Perspektiven der Wirtschaftspolitik, De Gruyter, vol. 18(2), pages 98-116, June.
    9. Insana, Alessandra, 2022. "Does systematic risk change when markets close? An analysis using stocks’ beta," Economic Modelling, Elsevier, vol. 109(C).
    10. Ho, Hsiao-Wei & Hsiao, Yu-Jen & Lo, Wen-Chi & Yang, Nien-Tzu, 2023. "Momentum investing and a tale of intraday and overnight returns: Evidence from Taiwan," Pacific-Basin Finance Journal, Elsevier, vol. 82(C).
    11. Kotaro Miwa, 2020. "Market Closures and Cross-sectional Stock Returns," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 27(1), pages 1-33, March.
    12. Turan G. Bali & Robert F. Engle & Yi Tang, 2017. "Dynamic Conditional Beta Is Alive and Well in the Cross Section of Daily Stock Returns," Management Science, INFORMS, vol. 63(11), pages 3760-3779, November.
    13. Andreas Neuhierl & Michael Weber & Michael Weber, 2017. "Monetary Momentum," CESifo Working Paper Series 6648, CESifo.
    14. Victoria Dobrynskaya, 2017. "Dynamic Momentum and Contrarian Trading," HSE Working papers WP BRP 61/FE/2017, National Research University Higher School of Economics.
    15. Cynthia M. Gong & Di Luo & Huainan Zhao, 2021. "Liquidity risk and the beta premium," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 44(4), pages 789-814, December.
    16. Andrew Detzel, 2017. "Monetary Policy Surprises, Investment Opportunities, And Asset Prices," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 40(3), pages 315-348, September.
    17. Poon, Percy & Yao, Tong & Zhang, Andrew (Jianzhong), 2022. "The alphas of beta and idiosyncratic volatility," Journal of Financial Markets, Elsevier, vol. 61(C).
    18. Akbas, Ferhat & Boehmer, Ekkehart & Jiang, Chao & Koch, Paul D., 2022. "Overnight returns, daytime reversals, and future stock returns," Journal of Financial Economics, Elsevier, vol. 145(3), pages 850-875.
    19. Michael Curran & Adnan Velic, 2020. "The CAPM, National Stock Market Betas, and Macroeconomic Covariates: a Global Analysis," Open Economies Review, Springer, vol. 31(4), pages 787-820, September.
    20. Barardehi, Yashar H. & Bernhardt, Dan & Da, Zhi & Mitch Warachka, Mitch, 2022. "Institutional Liquidity Demand and the Internalization of Retail Order Flow : The Tail Does Not Wag the Dog," The Warwick Economics Research Paper Series (TWERPS) 1394, University of Warwick, Department of Economics.

    More about this item

    Keywords

    Predictive Processing; Asset Pricing; CAPM; SML Slope; Betting-Against-Beta; Size Effect; Value Effect; Momentum Effect;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:pra:mprapa:120526. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Joachim Winter (email available below). General contact details of provider: https://edirc.repec.org/data/vfmunde.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.