Review of Peter Bossaerts, The Paradox of Asset Pricing
By 'the paradox of asset pricing' Peter Bossaerts refers to his contention that, despite its apparent generality and sophistication, the theory of finance has largely been a failure empirically. Bossaerts reviews the major areas of finance: theory, empirical methods, empirical results and experiments. The explanatory variables for average asset returns suggested by theory - market beta and consumption beta - predict returns less successfully than variables for which the theoretical basis is weak. This reviewer agrees with Bossaerts' assessment. Bossaerts proposes weakening the hypothesis of market efficiency from full rational expectations to efficient learning: agents update priors optimally - that is, according to Bayes' rule - but start with possibly biased priors. He develops ingenious empirical implications of this specification. For example, he shows that under efficient learning, inverse asset returns are fair games going backward in time (under some additional assumptions). Empirical implementation of these tests appear promising.
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Volume (Year): 10 (2003)
Issue (Month): 1 ()
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