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Do Investors Suffer from Money Illusion? A Direct Test of the Modigliani--Cohn Hypothesis

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  • Daniella Acker
  • Nigel W. Duck

Abstract

We propose a direct test of the explanation by Modigliani and Cohn (MC) for the positive correlation between inflation and equity values--that it results from investors' money illusion. This explanation, unlike its main rivals, suggests that because in inflationary periods dividends will, on average, be higher than expected, dividend announcements will trigger positive abnormal returns. These will be higher the higher the inflation, and the more levered the firm. The behavior of abnormal returns of US stocks on dividend-announcement days from 1955 to 2007 supports these predictions. We investigate alternative explanations of our results. None dominates MC's. Copyright 2013, Oxford University Press.

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  • Daniella Acker & Nigel W. Duck, 2013. "Do Investors Suffer from Money Illusion? A Direct Test of the Modigliani--Cohn Hypothesis," Review of Finance, European Finance Association, vol. 17(2), pages 565-596.
    • Handle: RePEc:oup:revfin:v:17:y:2013:i:2:p:565-596
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    Cited by:

    1. Tsai, I-Chun, 2020. "Alternative explanation of the money illusion: The effect of unexpected low inflation," International Review of Economics & Finance, Elsevier, vol. 69(C), pages 110-123.
    2. Krishnamurthy, Srinivasan & Pelletier, Denis & Warr, Richard S., 2018. "Inflation and equity mutual fund flows," Journal of Financial Markets, Elsevier, vol. 37(C), pages 52-69.
    3. Antonio J. Morales & Enrique Fatas, 2021. "Price competition and nominal illusion: experimental evidence and a behavioural model," SERIEs: Journal of the Spanish Economic Association, Springer;Spanish Economic Association, vol. 12(4), pages 607-632, December.

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