If You're NOT So Smart, Why Are You Rich? Robust Market Selection with General Recursive Preferences

Abstract

This paper provides a unified framework to study the equilibrium consumption allocations
in stochastic exchange economies where consumers’ preferences belong to a general class of
recursive preferences, encompassing expected-utility and several common non-expected utility
preferences. We provide a characterization of the long-run consumption dynamics when markets
are complete 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
survival of heterogeneous consumers is the robust long-run outcome in our general framework.
In particular, a consumer with incorrect beliefs can survive regardless of other consumers’
preferences and beliefs. Our results imply there is an inherent tension between two broadly
held tenets in economics and finance, that markets allocate resources efficiently and prices
eventually reflect correct beliefs.

Keywords: Market selection hypothesis, rational expectations, belief heterogeneity, heterogeneous consumers, recursive preferences, non-expected utility, robustness

JEL Classification: D50, D81