Natural Selection in Financial Markets: Does it Work?
38 Pages Posted: 15 Jan 2008
Date Written: April 25, 2008
Abstract
Can investors with incorrect beliefs survive in financial markets and have a significant impact on asset prices? My paper addresses this issue by analyzing a dynamic general equilibrium model where some investors have rational expectations while others have incorrect beliefs concerning the mean growth rate of the economy. The main result is that an investor can survive if and only if he has the lowest survival index, which is a function of his belief accuracy, patience parameter and relative risk aversion coefficient. If preferences are held constant across all investors, then those with incorrect beliefs cannot survive in the limit, though calibrations reveal that the selection process is excessively slow. But if preferences vary across investors, even slightly, it becomes possible for an irrational investor to dominate the market, even if his beliefs persistently and substantially deviate from the truth.
Keywords: Market selection, asset pricing, general equilibrium, heterogeneous beliefs
JEL Classification: B40, B52, C60, D50, D90, G12
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
The Term Structure of Interest Rates in a Pure Exchange Economy with Heterogeneous Investors
By Jiang Wang
-
Heterogeneous Expectations and Bond Markets
By Hongjun Yan and Wei Xiong
-
Heterogeneous Expectations and Bond Markets
By Hongjun Yan and Wei Xiong
-
The Price Impact and Survival of Irrational Traders
By Leonid Kogan, Stephen A. Ross, ...
-
The Price Impact and Survival of Irrational Traders
By Leonid Kogan, Stephen A. Ross, ...
-
Consensus Consumer and Intertemporal Asset Pricing with Heterogeneous Beliefs
By Elyes Jouini and Clotilde Napp
-
Equilibrium Portfolio Strategies in the Presence of Sentiment Risk and Excess Volatility
By Bernard Dumas, Alexander Kurshev, ...
-
Equilibrium Portfolio Strategies in the Presence of Sentiment Risk and Excess Volatility
By Bernard Dumas, Alexander Kurshev, ...