Does the Market Self-Correct? Asymmetrical Adjustment and the Structure of Economic Error
13 Pages Posted: 12 Dec 2005 Last revised: 25 Oct 2010
Date Written: 2006
While both errors of overoptimism and errors of overpessimism are possible in the face of imperfect information, the presence of option value from deferring a decision to exchange causes trader errors to be overpessimistically biased. This is problematic because unlike errors of overoptimism, errors of overpessimism are not 'automatically' revealed to the agents who make them. Furthermore, owing to the 'bad news principle of irreversible investment', these errors are likely to persist. We show how entrepreneurial activity corrects such errors and prevents their persistence, creating a tendency towards market efficiency despite the presence of imperfect information.
Keywords: Imperfect information, equilibration, entrepreneurship
JEL Classification: B53, D83, L26
Suggested Citation: Suggested Citation