Do the Effects of Individual Behavioral Biases Cancel Out?
46 Pages Posted: 4 Jan 2017 Last revised: 6 Jul 2021
Date Written: July 4, 2021
A major criticism of behavioral economics is that it has not shown that the idiosyncratic biases of individual investors lead to aggregate effects. We construct a model of a general-equilibrium production economy with a large number of firms and investors. Investors' beliefs about stock returns are determined endogenously based on their psychological distances from firms; consequently, investors are optimistic about some stocks and pessimistic about others. We consider two examples: one where portfolio errors cancel out and the other in which the behavioral biases cancel out when aggregated across investors. We show asset prices and macroeconomic aggregates are still distorted.
Keywords: Behavioral finance, money market, aggregate growth, stochastic discount factor.
JEL Classification: G02, E03, E44, G11, G41
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