Do Markets Prove Pessimists Right?

37 Pages Posted: 14 Nov 2018

See all articles by Jürgen Eichberger

Jürgen Eichberger

Heidelberg University - Alfred Weber Institute for Economics

Ani Guerdjikova

Cornell University - Department of Economics

Date Written: November 2018

Abstract

We study how ambiguity and ambiguity attitudes affect asset prices when consumers form their expectations based on past observations. In an overlapping generations economy with risk‐neutral yet ambiguity‐sensitive consumers, we describe limiting asset prices depending on the proportion of investor types. We then study the evolution of consumer‐type shares. With long memory, the market does not select for ambiguity neutrality. Whenever perceived ambiguity is sufficiently small, but positive, only pessimists survive and determine prices in the limit. With one‐period memory, equilibrium prices are determined by Bayesians. Yet, the average price of the risky asset is lower than its fundamental value.

Suggested Citation

Eichberger, Jürgen and Guerdjikova, Ani, Do Markets Prove Pessimists Right? (November 2018). International Economic Review, Vol. 59, Issue 4, pp. 2259-2295, 2018. Available at SSRN: https://ssrn.com/abstract=3284015 or http://dx.doi.org/10.1111/iere.12336

Jürgen Eichberger (Contact Author)

Heidelberg University - Alfred Weber Institute for Economics ( email )

Heidelberg, D-69117
Germany

Ani Guerdjikova

Cornell University - Department of Economics ( email )

414 Uris Hall
Ithaca, NY 14853-7601
United States

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