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Near-Rational Behaviour and Financial Market Fluctuations

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  • Wang, Yong

Abstract

This paper departs from the conventional assumption of unbounded rationality in the marketplace and investigates the effects of a suboptimal behavior in financial markets. A rule of thumb adopted by a group of agents is proven to be near-rational, in the sense that the costs borne by those agents are negligible. The paper argues that despite the insignificant consequences of the near-rational behavior from an individual standpoint, it can cause asset prices to significantly deviate from their rational equilibrium levels. Moreover, the impact of near-rational agents is found to be disproportionately large. The presence of near-rationality causes excessive volatility in observed market prices, as it amplifies the effects of an income shock on the financial market. Copyright 1993 by Royal Economic Society.

Suggested Citation

  • Wang, Yong, 1993. "Near-Rational Behaviour and Financial Market Fluctuations," Economic Journal, Royal Economic Society, vol. 103(421), pages 1462-1478, November.
  • Handle: RePEc:ecj:econjl:v:103:y:1993:i:421:p:1462-78
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    Cited by:

    1. Bagella, Michele & Becchetti, Leonardo, 1998. "The optimal financing strategy of a high-tech firm: The role of warrants," Journal of Economic Behavior & Organization, Elsevier, vol. 35(1), pages 1-23, March.
    2. Bagella, Michele & Becchetti, Leonardo & Carpentieri, Andrea, 2000. ""The first shall be last". Size and value strategy premia at the London Stock Exchange," Journal of Banking & Finance, Elsevier, vol. 24(6), pages 893-919, June.

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