Asset Pricing and Asymmetric Reasoning
64 Pages Posted: 17 May 2009 Last revised: 28 Nov 2014
Date Written: March 5, 2013
Abstract
We present a new theory of asset pricing and portfolio choices under asymmetric reasoning, contrast the predictions with those under asymmetric information, and present experimental evidence in favor of our theory. The Efficient Markets Hypothesis and its formal foundation, the Rational Expectations Equilibrium, predict that asymmetric information is irrelevant because prices correctly aggregate all available information. We argue here that asymmetric reasoning is fundamentally different: prices may not reflect all (types of) reasoning because (some) agents who observe prices that cannot be reconciled with their reasoning drop their reasoning while not giving prices the benefit of the doubt, and hence become sufficiently ambiguity averse so that they no longer directly influence prices. We present the results from an experiment, where, through manipulation of aggregate risk, we separately test the price and choice implications of our theory. Consistent with our theory, we find that i) a significant fraction of our subjects become price-insensitive, that ii) mispricing decreases as the fraction of price-sensitive agents increases when there is no aggregate risk, and iii) price-insensitive agents tend to trade to more balanced portfolios when there is aggregate risk.
Keywords: asset pricing, ambiguity aversion, cognitive
JEL Classification: G11, G12, G14
Suggested Citation: Suggested Citation
Do you have a job opening that you would like to promote on SSRN?
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, ...