Asset Pricing and Asymmetric Reasoning

64 Pages Posted: 17 May 2009 Last revised: 28 Nov 2014

See all articles by Elena N. Asparouhova

Elena N. Asparouhova

University of Utah - David Eccles School of Business

Peter Bossaerts

University of Melbourne - Department of Finance

Jon X. Eguia

Michigan State University - Department of Economics

William R. Zame

University of California, Los Angeles (UCLA) - Department of Economics

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

Asparouhova, Elena N. and Bossaerts, Peter L. and Eguia, Jon X. and Zame, William R., Asset Pricing and Asymmetric Reasoning (March 5, 2013). Swiss Finance Institute Research Paper No. 09-20, Available at SSRN: https://ssrn.com/abstract=1405415 or http://dx.doi.org/10.2139/ssrn.1405415

Elena N. Asparouhova (Contact Author)

University of Utah - David Eccles School of Business ( email )

1645 E Campus Center Dr
Salt Lake City, UT 84112-9303
United States

Peter L. Bossaerts

University of Melbourne - Department of Finance ( email )

Faculty of Economics and Commerce
Department of Finance
Carlton, Victoria 3010
Australia

HOME PAGE: http://bmmlab.org

Jon X. Eguia

Michigan State University - Department of Economics ( email )

East Lansing, MI 48824
United States

William R. Zame

University of California, Los Angeles (UCLA) - Department of Economics ( email )

Box 951477
Los Angeles, CA 90095-1477
United States
310-206-9463 (Phone)

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