Asset Pricing In a World of Imperfect Foresight

53 Pages Posted: 18 Jun 2020 Last revised: 30 Nov 2022

See all articles by Peter Bossaerts

Peter Bossaerts

University of Cambridge

Felix Fattinger

WU Vienna University of Economics and Business

Frans van den Bogaerde

affiliation not provided to SSRN

Wenhao Yang

Chinese University of Hong Kong, Shenzhen

Date Written: November 28, 2022

Abstract

A key assumption of dynamic asset pricing theory is that agents have perfect foresight: for all future contingencies, they correctly foresee the corresponding equilibrium prices. Is it possible for prices to still reflect perfect foresight even if agents have imperfect foresight? We answer affirmatively, provided agents exhibit a mild form of narrow framing, which we refer to as dynamic narrow framing: while accounting for future endowments, agents ignore re-trading opportunities. This behavior vastly simplifies computations of optimal choices. With a controlled experiment, we verify that our behavioral assumption explains both prices and choices. Our findings allow us to re-interpret the successes and failures of traditional tests of asset pricing theory on historical data from the field.

Keywords: Rational Expectations, Perfect Foresight, Narrow Framing, Dynamic Asset Pricing

JEL Classification: D51, D84, G12, G14

Suggested Citation

Bossaerts, Peter L. and Fattinger, Felix and van den Bogaerde, Frans and Yang, Wenhao, Asset Pricing In a World of Imperfect Foresight (November 28, 2022). Available at SSRN: https://ssrn.com/abstract=3610634 or http://dx.doi.org/10.2139/ssrn.3610634

Peter L. Bossaerts (Contact Author)

University of Cambridge ( email )

Faculty of Economics
Cambridge, CB3 9DD
United Kingdom

Felix Fattinger

WU Vienna University of Economics and Business ( email )

Welthandelsplatz 1, Building D1, 3rd Floor
Vienna, 1020
Austria

Frans Van den Bogaerde

affiliation not provided to SSRN

Wenhao Yang

Chinese University of Hong Kong, Shenzhen ( email )

2001 Longxiang Road, Longgang District
Shenzhen, 518172
China

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