Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)
Stephen A. Ross
Massachusetts Institute of Technology (MIT) - Sloan School of Management; Yale University - International Center for Finance
Massachusetts Institute of Technology (MIT) - Sloan School of Management; China Academy of Financial Research (CAFR); National Bureau of Economic Research (NBER)
Mark M. Westerfield
University of Washington
AFA 2009 San Francisco Meetings Paper
The hypothesis that financial markets punish traders who make relatively inaccurate forecasts and eventually eliminate the effect of their beliefs on prices is of fundamental importance to the standard modeling paradigm in asset pricing. We establish straightforward necessary and sufficient conditions for agents making inferior forecasts to survive and to affect prices in the long run in a general setting with minimal restrictions on endowments, beliefs, or utility functions. We describe a new mechanism for the distinction between survival and price impact in a broad class of economies. Our results cover economies with time-separable utility functions, including possibly state-dependent preferences, such as external habit formation.
Number of Pages in PDF File: 47
Keywords: Market Selection, Heterogeneous Beliefs, State-Dependent Utility, Survival, Price Impact
JEL Classification: G0, G14, D51
Date posted: March 25, 2008 ; Last revised: September 16, 2011
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