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Market Power, Survival and Accuracy of Predictions in Financial Markets

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  • Patrick Leoni
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    Abstract

    This paper aims to show that the market selection hypothesis in finance is not solely driven by the competitiveness of such markets, as was originally claimed by Alchian [1] and Friedman [4]. Within a standard intertemporal General Equilibrium framework, we allow for an agent to have enough influence on financial markets to strategically affect prices of assets traded. We then show that, as in Sandroni [15], the agent’ long-run consumption will vanish if she makes less accurate predictions than the market, and maintain her market power otherwise. We conclude that the Darwinian justification to this market selection is not the only explanation for the eventual domination of agents making the most accurate predictions. Rather, we claim that the origin of market selection, and in turn of the common prior assumption in asset pricing, is associated with the ability to foresee accurately market uncertainty.

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    Bibliographic Info

    Paper provided by Institute for Empirical Research in Economics - University of Zurich in its series IEW - Working Papers with number 216.

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    Handle: RePEc:zur:iewwpx:216

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    Keywords: market imperfection; asset pricing; learning;

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    1. Hart, Oliver D, 1979. "Monopolistic Competition in a Large Economy with Differentiated Commodities," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 46(1), pages 1-30, January.
    2. Hellwig, Martin F., 1980. "On the aggregation of information in competitive markets," Journal of Economic Theory, Elsevier, Elsevier, vol. 22(3), pages 477-498, June.
    3. Blume, Lawrence & Easley, David, 1992. "Evolution and market behavior," Journal of Economic Theory, Elsevier, Elsevier, vol. 58(1), pages 9-40, October.
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