Tom Engsted and Thomas Q. Pedersen receive large grant from DFF

Professor Tom Engsted and associate professor Thomas Quistgaard Pedersen have been awarded a grant of DKK 2.6 million from The Danish Council of Independent Research (DFF – Research Project 1) for the period January 2018 – December 2020 for their project entitled “Money Illusion”.

The project proposes new theoretical and empirical research that aims to analyze the effect of money illusion in stock, bond, currency, and housing markets. Money illusion refers to the phenomenon where people confuse nominal with real values, i.e. they ignore inflation in processing information and in making decisions. In terms of theoretical contribution, the project develops novel equilibrium asset pricing models inspired by the consumption-based long-run risk literature. The project incorporates money illusion into this type of model by allowing the representative agent to discount real cash flows using a nominal discount factor. To formally test the presence of money illusion, the project estimates the models using empirical methods that can handle latent state variables, which are an integral part of this type of model. The project also studies potential competing explanations of the relation between inflation and real asset prices such as inflation non-neutrality.