Interactions between Domestic and Foreign Investment

65 Pages Posted: 28 May 2004 Last revised: 11 Apr 2008

See all articles by Robert E. Lipsey

Robert E. Lipsey

National Bureau of Economic Research (NBER) at New York (Deceased)

Guy V. G. Stevens

Government of the United States of America - Division of International Finance (IFDP); National Bureau of Economic Research (NBER)

Date Written: September 1988

Abstract

We present a model of portfolio allocation by noise traders who form incorrect expectations about the variance of the return distribution of a particular asset. We show that for many types of misperceptions, as long as such noise traders do not affect prices, they earn higher expected returns than do rational investors with similar degrees of risk aversion. Moreover, many such noise traders survive and dominate the market in terms of wealth in the long run, in the sense that the probability that noise traders will eventually have a high share of the economy's wealth is arbitrarily close to one. Noise traders come to dominate the market despite the fact that they take excessive risk that skews the distribution of their long run wealth and despite their excessive consumption. We conclude that the theoretical case against the long run viability of noise traders is by no means as clear cut as is commonly supposed.

Suggested Citation

Lipsey, Robert E. and Stevens, Guy V. G., Interactions between Domestic and Foreign Investment (September 1988). NBER Working Paper No. w2714. Available at SSRN: https://ssrn.com/abstract=226863

Robert E. Lipsey (Contact Author)

National Bureau of Economic Research (NBER) at New York (Deceased)

Guy V. G. Stevens

Government of the United States of America - Division of International Finance (IFDP)

20th St. and Constitution Ave.
Washington, DC 20551
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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