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Prices and Portfolio Choices in Financial Markets: Theory, Econometrics, Experiments

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  • Peter Bossaerts
  • Charles Plott
  • William R. Zame

Abstract

Many tests of asset-pricing models address only the pricing predictions, but these pricing predictions rest on portfolio choice predictions that seem obviously wrong. This paper suggests a new approach to asset pricing and portfolio choices based on unobserved heterogeneity. This approach yields the standard pricing conclusions of classical models but is consistent with very different portfolio choices. Novel econometric tests link the price and portfolio predictions and take into account the general equilibrium effects of sample-size bias. This paper works through the approach in detail for the case of the classical capital asset pricing model (CAPM), producing a model called CAPM+ε. When these econometric tests are applied to data generated by large-scale laboratory asset markets that reveal both prices and portfolio choices, CAPM+εis not rejected. Copyright The Econometric Society 2007.

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File URL: http://hdl.handle.net/10.1111/j.1468-0262.2007.00780.x
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Bibliographic Info

Article provided by Econometric Society in its journal Econometrica.

Volume (Year): 75 (2007)
Issue (Month): 4 (07)
Pages: 993-1038

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Handle: RePEc:ecm:emetrp:v:75:y:2007:i:4:p:993-1038

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Cited by:
  1. Eichberger, Jürgen & Rheinberger, Klaus & Summer, Martin, 2012. "Credit risk in general equilibrium," Working Paper Series 1445, European Central Bank.
  2. Pesaran, M. Hashem & Yamagata, Takashi, 2012. "Testing CAPM with a Large Number of Assets," IZA Discussion Papers 6469, Institute for the Study of Labor (IZA).
  3. Anufriev, M. & Tuinstra, J. & Bao, T., 2013. "Fund Choice Behavior and Estimation of Switching Models: An Experiment," CeNDEF Working Papers 13-04, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
  4. Pesaran, M. H. & Yamagata, T., 2012. "Testing CAPM with a Large Number of Assets (Updated 28th March 2012)," Cambridge Working Papers in Economics 1210, Faculty of Economics, University of Cambridge.
  5. Catherine Eckel & Rick Wilson, 2006. "Internet cautions: Experimental games with internet partners," Experimental Economics, Springer, vol. 9(1), pages 53-66, April.

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