If You're NOT So Smart, Why Are You Rich? Robust Market Selection with General Recursive Preferences
58 Pages Posted: 28 Nov 2023
Date Written: October 29, 2023
This paper provides a unified framework to study the long-run dynamics of competitive equilibrium consumption allocations in stochastic exchange economies with complete markets and multiple consumers whose preferences belong to a general class of recursive preferences, encompassing both expected-utility and various common non-expected utility preferences. We provide a characterization of the long-run consumption dynamics and apply it to study the robustness of the market selection hypothesis that market favors consumers with more accurate beliefs. In sharp contrast to the results for the class of expected utility studied by Sandroni (2000) and Blume and Easley (2006), we show that the existence of multiple survivors is the robust long-run outcome for our general class of preferences. Our results imply there is an inherent tension between two broadly held tenets in economics and finance, that markets allocate resources efficiently and equilibrium allocations can eventually be described as a rational expectations equilibrium.
Keywords: Market selection hypothesis, rational expectations, belief heterogeneity, heterogeneous consumers, recursive preferences, non-expected utility, robustness
JEL Classification: D50, D81
Suggested Citation: Suggested Citation