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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

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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Bibliographic Info

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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  1. Armen A. Alchian, 1950. "Uncertainty, Evolution, and Economic Theory," Journal of Political Economy, University of Chicago Press, vol. 58, pages 211.
  2. D. Blackwell & L. Dubins, 2010. "Merging of Opinions with Increasing Information," Levine's Working Paper Archive 565, David K. Levine.
  3. 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.
  4. Blume, Lawrence & Easley, David, 1992. "Evolution and market behavior," Journal of Economic Theory, Elsevier, vol. 58(1), pages 9-40, October.
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