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Bounded Rationality and Asset Pricing

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  • Tony Berrada

    (University of Lausanne and Swiss Finance Institute)

Abstract

We consider a pure exchange economy with incomplete information. Some agents in the economy display learning bias and over- or underreact to the arrival of new information. We study, by simulation, the distribution of irrational agents’ consumption shares. We find that over a reasonable horizon (50 years) under- or over-reaction has little impact on an agent’s consumption share, when parameters of the model are chosen to fit aggregate consumption data in the US. We also show that agents’impact on prices is increasing in their consumption share and conclude that biased agents can significantly influence equilibrium quantities.

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Bibliographic Info

Paper provided by Swiss Finance Institute in its series Swiss Finance Institute Research Paper Series with number 06-07.

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Length: 47 pages
Date of creation: Aug 2003
Date of revision: Jun 2006
Handle: RePEc:chf:rpseri:rp0607

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Web page: http://www.SwissFinanceInstitute.ch
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Related research

Keywords: Bounded rationality; incomplete information; equilibrium;

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Cited by:
  1. Dumas, Bernard J & Kurshev, Alexander & Uppal, Raman, 2005. "What Can Rational Investors Do About Excessive Volatility and Sentiment Fluctuations?," CEPR Discussion Papers 5367, C.E.P.R. Discussion Papers.
  2. Bernard Dumas & Alexander Kurshev & Raman Uppal, 2009. "Equilibrium Portfolio Strategies in the Presence of Sentiment Risk and Excess Volatility," Journal of Finance, American Finance Association, vol. 64(2), pages 579-629, 04.
  3. Hongjun Yan, 2008. "Natural Selection in Financial Markets: Does it Work?," Yale School of Management Working Papers amz2648, Yale School of Management, revised 01 May 2008.

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