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The Limits of Investor Behavior

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  • MARK LOEWENSTEIN
  • GREGORY A. WILLARD

Abstract

Many models use noise trader risk and corresponding violations of the Law of One Price to explain pricing anomalies, but include a storage technology in perfectly elastic supply or unlimited asset liability. Storage allows aggregate consumption risk to differ from exogenous fundamental risk, but using aggregate consumption as a factor for asset returns can make noise trader risk superfluous. Using (i) limited asset liability and limited storage withdrawals, or (ii) an endogenous locally riskless interest rate eliminates violations of the Law of One Price. Our main results use only budget equations and market clearing, and require virtually no assumptions about behavior.

Suggested Citation

  • Mark Loewenstein & Gregory A. Willard, 2006. "The Limits of Investor Behavior," Journal of Finance, American Finance Association, vol. 61(1), pages 231-258, February.
  • Handle: RePEc:bla:jfinan:v:61:y:2006:i:1:p:231-258
    DOI: 10.1111/j.1540-6261.2006.00835.x
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    Cited by:

    1. Hugonnier, Julien, 2012. "Rational asset pricing bubbles and portfolio constraints," Journal of Economic Theory, Elsevier, vol. 147(6), pages 2260-2302.
    2. Guofu Zhou, 2018. "Measuring Investor Sentiment," Annual Review of Financial Economics, Annual Reviews, vol. 10(1), pages 239-259, November.
    3. Buss, Adrian & Dumas, Bernard & Uppal, Raman & Vilkov, Grigory, 2016. "The intended and unintended consequences of financial-market regulations: A general-equilibrium analysis," Journal of Monetary Economics, Elsevier, vol. 81(C), pages 25-43.
    4. Zamri Ahmad & Haslindar Ibrahim & Jasman Tuyon, 2017. "Behavior of fund managers in Malaysian investment management industry," Qualitative Research in Financial Markets, Emerald Group Publishing Limited, vol. 9(3), pages 205-239, August.
    5. Brunnermeier, Markus K. & Oehmke, Martin, 2013. "Bubbles, Financial Crises, and Systemic Risk," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 1221-1288, Elsevier.
    6. Ilomaki Jukka & Laurila Hannu, 2017. "Endogenous Real Risk-Free Rate, the Central Bank, and Stock Market," Working Papers 1713, Tampere University, Faculty of Management and Business, Economics.
    7. Baldeaux, Jan & Ignatieva, Katja & Platen, Eckhard, 2018. "Detecting money market bubbles," Journal of Banking & Finance, Elsevier, vol. 87(C), pages 369-379.
    8. Hanson, Samuel & Malkhozov, Aytek & Venter, Gyuri, 2022. "Demand-supply imbalance risk and long-term swap spreads," LSE Research Online Documents on Economics 118868, London School of Economics and Political Science, LSE Library.
    9. Kenning, Peter & Mohr, Peter & Erk, Susanne & Walter, Henrik & Plassmann, Hilke, 2006. "The role of fear in home-biased decision making: first insights from neuroeconomics," MPRA Paper 1076, University Library of Munich, Germany, revised 18 Nov 2006.
    10. Bernard Dumas & Alexander Kurshev & Raman Uppal, 2009. "Equilibrium Portfolio Strategies in the Presence of Sentiment Risk and Excess Volatility," Journal of Finance, American Finance Association, vol. 64(2), pages 579-629, April.
    11. Arnold, Lutz G. & Brunner, Stephan, 2015. "The economics of rational speculation in the presence of positive feedback trading," The Quarterly Review of Economics and Finance, Elsevier, vol. 57(C), pages 161-174.
    12. Martin Larsson, 2013. "Non-Equivalent Beliefs and Subjective Equilibrium Bubbles," Papers 1306.5082, arXiv.org.
    13. Szymon Lis, 2022. "Investor Sentiment in Asset Pricing Models: A Review," Working Papers 2022-14, Faculty of Economic Sciences, University of Warsaw.
    14. Li, Kai & Liu, Jun, 2023. "Extrapolative asset pricing," Journal of Economic Theory, Elsevier, vol. 210(C).
    15. Isaenko, Sergey, 2015. "Equilibrium theory of stock market crashes," Journal of Economic Dynamics and Control, Elsevier, vol. 60(C), pages 73-94.

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