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If You're so Smart, why Aren't You Rich? Belief Selection in Complete and Incomplete Markets

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Lawrence Blume
David Easley

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Abstract

This paper provides an analysis of the asymptotic properties of Pareto optimal consumption allocations in a stochastic general equilibrium model with heterogeneous consumers. In particular, we investigate the market selection hypothesis that markets favor traders with more accurate beliefs. We show that in any Pareto-optimal allocation whether each consumer vanishes or survives is determined entirely by discount factors and beliefs. Whereas equilibrium allocations in economies with complete markets are Pareto optimal, our results characterize the limit behavior of these economies. We show that, all else equal, the market selects for consumers who use Bayesian learning with the truth in the support of their prior and selects among Bayesians according to the size of their parameter space. Finally, we show that in economies with incomplete markets, these conclusions may not hold. With incomplete markets, payoff functions can matter for long-run survival, and the market selection hypothesis fails. Copyright The Econometric Society 2006.

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File URL: http://hdl.handle.net/10.1111/j.1468-0262.2006.00691.x
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Article provided by Econometric Society in its journal Econometrica.

Volume (Year): 74 (2006)
Issue (Month): 4 (07)
Pages: 929-966
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Handle: RePEc:ecm:emetrp:v:74:y:2006:i:4:p:929-966

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Blume, L. E. & Bray, M. M. & Easley, D., 1982. "Introduction to the stability of rational expectations equilibrium," Journal of Economic Theory, Elsevier, vol. 26(2), pages 313-317, April. [Downloadable!] (restricted)
  2. Blume, Lawrence & Easley, David, 1992. "Evolution and market behavior," Journal of Economic Theory, Elsevier, vol. 58(1), pages 9-40, October. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. James Dow & Gary Gorton, 2006. "Noise Traders," NBER Working Papers 12256, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. Spyros Skouras, 2001. "Decisionmetrics: A Decision-Based Approach to Econometric Modeling," Working Papers 01-11-064, Santa Fe Institute.
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  3. Pablo F Beker & Emilio Espino, 2007. "The Dynamics of Efficient Asset Trading with Heterogeneous Beliefs," Levine's Bibliography 122247000000001715, UCLA Department of Economics. [Downloadable!]
  4. Leonid Kogan & Stephen Ross & Jiang Wnag & Mark Westerfield, 2003. "The Price Impact and Survival of Irrational Traders," NBER Working Papers 9434, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  5. Tarek Coury & Emanuela Sciubba, 2006. "Belief Heterogeneity and Survival in Incomplete Markets," Birkbeck Working Papers in Economics and Finance 0613, Birkbeck, School of Economics, Mathematics & Statistics. [Downloadable!]
  6. Lensberg, Terje & Schenk-Hoppé, Klaus Reiner, 2006. "On the Evolution of Investment Strategies and the Kelly Rule – A Darwinian Approach," Discussion Papers 2006/23, Department of Finance and Management Science, Norwegian School of Economics and Business Administration. [Downloadable!]
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  7. Igor Evstigneev & Thorsten Hens & Klaus Reiner Schenk-Hoppé, 2003. "Evolutionary Stable Stock Markets," Discussion Papers 03-39, University of Copenhagen. Department of Economics. [Downloadable!]
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  8. Pablo F. Beker & Subir Chattopadhyay, 2006. "Economic Survival When Markets Are Incomplete," Working Papers. Serie AD 2006-19, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie). [Downloadable!]
    Other versions:
  9. Franklin Allen, 2001. "Do Financial Institutions Matter?," Center for Financial Institutions Working Papers 01-04, Wharton School Center for Financial Institutions, University of Pennsylvania. [Downloadable!]
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