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Belief Heterogeneity and Survival in Incomplete Markets

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  • Tarek Coury
  • Emanuela Sciubba

    (Department of Economics, Mathematics & Statistics, Birkbeck)

Abstract

In complete markets economies (Sandroni [15]), or in economies with Pareto optimal outcomes (Blume and Easley [9]), the market selection hypothesis holds, as long as traders have identical discount factors. Traders who survive must have beliefs that merge with the truth. We show that in incomplete markets, regardless of traders’ discount factors, the market selects for a range of beliefs, at least some of which do not merge with the truth. We also show that impatient traders with incorrect beliefs can survive and that these incorrect beliefs impact prices. These beliefs may be chosen so that they are far from the truth.

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File URL: http://www.bbk.ac.uk/ems/research/wp/PDF/BWPEF0613.pdf
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Paper provided by Birkbeck, Department of Economics, Mathematics & Statistics in its series Birkbeck Working Papers in Economics and Finance with number 0613.

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Date of creation: Nov 2006
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Handle: RePEc:bbk:bbkefp:0613

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Keywords: Incomplete markets; market selection hypothesis; belief selection;

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  1. Magill, M. & Quinzii, M., 1992. "Infinite Horizon Incomplete Markets," Papers 413a, California Davis - Institute of Governmental Affairs.
  2. J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann,, . "The Survival of Noise Traders in Financial Markets," J. Bradford De Long's Working Papers _123, University of California at Berkeley, Economics Department.
  3. Sciubba, E., 1999. "Asymmetric Information and Survival in Financial Markets," Cambridge Working Papers in Economics 9908, Faculty of Economics, University of Cambridge.
  4. Blume, Lawrence & Easley, David, 1992. "Evolution and market behavior," Journal of Economic Theory, Elsevier, vol. 58(1), pages 9-40, October.
  5. Beker, Pablo & Subir Chattopadhyay, 2009. "Consumption Dynamics in General Equilibrium : A Characterisation when Markets are Incomplete," The Warwick Economics Research Paper Series (TWERPS) 921, University of Warwick, Department of Economics.
  6. Bewley, Truman F., 1972. "Existence of equilibria in economies with infinitely many commodities," Journal of Economic Theory, Elsevier, vol. 4(3), pages 514-540, June.
  7. Biais, Bruno & Shadur, Raphael, 2000. "Darwinian selection does not eliminate irrational traders," European Economic Review, Elsevier, vol. 44(3), pages 469-490, March.
  8. Larry Blume & David Easley, 2001. "If You're So Smart, Why Aren't You Rich? Belief Selection in Complete and Incomplete Markets," Cowles Foundation Discussion Papers 1319, Cowles Foundation for Research in Economics, Yale University.
  9. Sciubba, E., 1999. "The Evolution of Portfolio Rules and the Capital Asset Pricing Model," Cambridge Working Papers in Economics 9909, Faculty of Economics, University of Cambridge.
  10. J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, . "Noise Trader Risk in Financial Markets," J. Bradford De Long's Working Papers _124, University of California at Berkeley, Economics Department.
  11. Armen A. Alchian, 1950. "Uncertainty, Evolution, and Economic Theory," Journal of Political Economy, University of Chicago Press, vol. 58, pages 211.
  12. Shefrin, Hersh & Statman, Meir, 1994. "Behavioral Capital Asset Pricing Theory," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 29(03), pages 323-349, September.
  13. Araujo, Aloisio, 1985. "Lack of Pareto Optimal Allocations in Economies with Infinitely Many Commodities: The Need for Impatience," Econometrica, Econometric Society, vol. 53(2), pages 455-61, March.
  14. Alvaro Sandroni, 2000. "Do Markets Favor Agents Able to Make Accurate Predicitions?," Econometrica, Econometric Society, vol. 68(6), pages 1303-1342, November.
  15. Aloisio Araujo & Alvaro Sandroni, 1999. "On the Convergence to Homogeneous Expectations when Markets Are Complete," Econometrica, Econometric Society, vol. 67(3), pages 663-672, May.
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Cited by:
  1. Tilman Klumpp & Xuejuan Su, 2013. "A theory of perceived discrimination," Economic Theory, Springer, vol. 53(1), pages 153-180, May.
  2. Beker, Pablo & Chattopadhyay, Subir, 2010. "Consumption dynamics in general equilibrium: A characterisation when markets are incomplete," Journal of Economic Theory, Elsevier, vol. 145(6), pages 2133-2185, November.
  3. Viktor Tsyrennikov & Thomas Sargent & Timothy Cogley, 2012. "Wealth Dynamics in a Bond Economy with Heterogeneous Beliefs," 2012 Meeting Papers 1079, Society for Economic Dynamics.
  4. Dan Cao, 2011. "Collateral Shortages, Asset Price and Investment Volatility with Heterogeneous Beliefs," Working Papers gueconwpa~11-11-01, Georgetown University, Department of Economics.
  5. 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).
  6. Ani Guerdijkova & Emanuela Sciubba, 2012. "Survival with Ambiguity," Birkbeck Working Papers in Economics and Finance 1216, Birkbeck, Department of Economics, Mathematics & Statistics.

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