Absent Imposition of 'Boundary Rationality Conditions', Can Evidence for Pricing of Behavioral Biases of Economic Agents Be Robust?
29 Pages Posted: 30 Oct 2019
Date Written: October 20, 2019
This study unambiguously demonstrates that, absent independent establishment of boundary rationality conditions for stock prices, behavioral axioms, such as overconfidence, overreaction, underreaction, and attribution bias cannot be robustly applied to rationalization of market phenomena that are generated by rational economic agents. This general equilibrium outcome is predicated on predictions of a formal theoretical model. In the model, whenever behavioral biases feasibly can influence market returns, qualitatively, such effects cannot be distinguished from presence, in stock markets, of mixtures of 'sophisticated' and 'naive' economic agents. In this respect, the model establishes that any of, rational components of stock prices, information variables that support presence of mixtures of sophisticated and naive agents within stock markets, or behavioral biases, have feasibility of generation of pattern of stock return momentum and reversals. An important side result is the prediction that behavioral axioms, such as overreaction, and underreaction, which of necessity must have opposite effects on prices, cannot subsist contemporaneously within dichotomous groupings of rational economic agents who invest in stock markets.
Keywords: Rationality, Behavioral Bias, Sophisticated Agents, Naive Agents, Underreaction, Overconfidence.
JEL Classification: G02, G14, D53, D03
Suggested Citation: Suggested Citation