2018/07 | LEM Working Paper Series | ||||||||||||||||
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Rationality and Asset Prices under Belief Heterogeneity |
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Daniele Giachini |
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Keywords | |||||||||||||||||
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Belief Heterogeneity, Rationality, Investment Rules, Heuristics, Financial Markets, Asset Pricing
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JEL Classifications | |||||||||||||||||
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C60, D53, D81, G11, G12
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Abstract | |||||||||||||||||
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In this paper I study the relationship between rationality and asset
prices when agents have heterogeneous and incorrect beliefs about
future events. Using the fully rational pricing as a benchmark, I show
that when agents behave according to the Subjective Generalized Kelly
rule (Bottazzi et al., 2017), which is not optimal under agents’
beliefs, the long-run pricing performance is at least as good as the
one emerging from an economy where agents maximize their preferences
under rational price expectations. Indeed, there exist generic cases
in which expected long-run prices of the Subjective Generalized Kelly
economy approximate better the rational pricing than those attained by
the utility maximizers economy. Moreover in the limit of agents having
a discount factor equal to one the prices of the Subjective
Generalized Kelly economy converge to those of the fully rational
economy. Hence the fact that agents use non-optimal (heuristic)
decision rules may correct for biases in beliefs and, as a
consequence, improve the pricing performance of the economy.
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