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Market selection with idiosyncratic uncertainty

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  • Sihvonen, Markus

Abstract

I analyze the survival probabilities of different types of agents in a general equilibrium model with disagreement over idiosyncratic uncertainties. I find that such biases create a separation between individual and group level survival: even when the survival probability of a single irrational agent tends to zero, these agents may still succeed as a whole. Effectively the irrational agent population can survive due to a vanishingly small group of increasingly rich agents. Disagreement over idiosyncratic uncertainties distorts savings decisions and interest rates, but idiosyncratic risks are not priced. Simulations confirm that the limiting results are relevant when the population of irrational agents is large.

Suggested Citation

  • Sihvonen, Markus, 2019. "Market selection with idiosyncratic uncertainty," Journal of Economic Theory, Elsevier, vol. 182(C), pages 143-160.
    • Handle: RePEc:eee:jetheo:v:182:y:2019:i:c:p:143-160
    DOI: 10.1016/j.jet.2019.04.005
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    References listed on IDEAS

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    Cited by:

    1. Han, Kookyoung, 2021. "Self-enforcement, heterogeneous agents, and long-run survival," Economics Letters, Elsevier, vol. 204(C).
    2. Martinez, Joseba & Philippon, Thomas & Sihvonen, Markus, 2022. "Does a currency union need a capital market union?," Journal of International Economics, Elsevier, vol. 139(C).
    3. Joseba Martinez & Thomas Philippon & Markus Sihvonen, 2019. "Does a Currency Union Need a Capital Market Union? Risk Sharing via Banks and Markets," NBER Working Papers 26026, National Bureau of Economic Research, Inc.

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    Keywords

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    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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