Evolutionary Strategic Beliefs and Financial Markets
36 Pages Posted: 20 Oct 2011
Date Written: June 28, 2011
We provide a discipline for belief formation through an evolutionary process which favors beliefs leading to higher utility levels at the Walrasian equilibrium. We show that such an evolutionary process converges to the Nash equilibrium in a game of strategic beliefs choices. The asymptotic beliefs are subjective and heterogeneous across the agents. Optimism (resp. overconfidence) as well as pessimism (resp. doubt) both emerge from the evolutionary process. Furthermore, we obtain a positive correlation between pessimism (resp. doubt) and risk-tolerance. We analyze the equilibrium characteristics. Under reasonable assumptions, the consensus belief is pessimistic and, as a consequence, the risk premium is higher than in a standard setting.
Keywords: belief formation, strategic beliefs, optimal beliefs, distorded beliefs, pessimism, risk premium
JEL Classification: G12, D03, D53, D81
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