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Unbiased Disagreement in Financial Markets, Waves of Pessimism and the Risk-Return Trade-off

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  • Elyès Jouini
  • Clotilde Napp

Abstract

Can investors with irrational beliefs be neglected as long as they are rational on average? Do their trades cancel out with no consequences on prices, as implicitly assumed by traditional models? We consider a model with irrational investors, who are rational on average. We obtain waves of pessimism and optimism that lead to countercyclical market prices of risk and procyclical risk-free rates. The variance of the state price density is greatly increased. The long run risk-return relation is modified; in particular, the long run market price of risk might be higher than both the instantaneous and the rational ones. Copyright 2010, Oxford University Press.

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Bibliographic Info

Article provided by European Finance Association in its journal Review of Finance.

Volume (Year): 15 (2010)
Issue (Month): 3 ()
Pages: 575-601

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Handle: RePEc:oup:revfin:v:15:y:2010:i:3:p:575-601

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Citations

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Cited by:
  1. Xue-Zhong He, 2012. "Recent Developments on Heterogeneous Beliefs and Adaptive Behaviour of Financial Markets," Research Paper Series 316, Quantitative Finance Research Centre, University of Technology, Sydney.
  2. Xue-Zhong He & Lei Shi & Min Zheng, 2012. "Asset Pricing Under Keeping Up With the Joneses and Heterogeneous Beliefs," Research Paper Series 302, Quantitative Finance Research Centre, University of Technology, Sydney.
  3. Xue-Zhong He & Lei Shi, 2012. "Heterogeneous Beliefs and the Cross-Section of Asset Returns," Research Paper Series 303, Quantitative Finance Research Centre, University of Technology, Sydney.
  4. Hongjun Yan, 2010. "Is Noise Trading Cancelled Out by Aggregation?," Management Science, INFORMS, vol. 56(7), pages 1047-1059, July.
  5. Xue-Zhong He & Lei Shi, 2012. "Heterogeneous Beliefs and the Performances of Optimal Portfolios," Research Paper Series 301, Quantitative Finance Research Centre, University of Technology, Sydney.

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