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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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  • Larry Blume

    (Cornell University)

  • David Easley

    (Cornell University)

Abstract

This paper provides an analysis of the asymptotic properties of 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. Since 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 the their parameter space. Finally, we show that in economies with incomplete markets these conclusions may not hold. Payoff functions can matter for long run survival, and the market selection hypothesis fails.

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Bibliographic Info

Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1319.

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Length: 38 pages
Date of creation: Aug 2001
Date of revision:
Handle: RePEc:cwl:cwldpp:1319

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Related research

Keywords: Market selection hypothesis; subjective beliefs; general equilibrium; incomplete markets; complete markets;

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