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Rational Markets: Yes or No? The Affirmative Case

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  • Rubinstein, Mark

Abstract

This paper presents the logic behind the increasingly neglected proposition that prices set in developed financial markets are determined as if all investors are rational. It contends that realistically, market rationality needs to be defined so as to allow investors to be uncertain about the characteristics of other investors in the market. It also argues that investor irrationality, to the extent it affects prices, is particularly likely to be manifest through overconfidence, which in turn is likely to make the market in an important sense too efficient, rather than less efficient, in reflecting information. To illustrate, the paper ends by re-examining some of the most serious evidence against market rationality: excess volatility, the risk premium puzzle, the size anomaly, calendar effects and the 1987 stock market crash

Suggested Citation

  • Rubinstein, Mark, 2000. "Rational Markets: Yes or No? The Affirmative Case," Research Program in Finance, Working Paper Series qt22q318mh, Research Program in Finance, Institute for Business and Economic Research, UC Berkeley.
  • Handle: RePEc:cdl:rpfina:qt22q318mh
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    Cited by:

    1. Stracca, Livio, 2004. "Behavioral finance and asset prices: Where do we stand?," Journal of Economic Psychology, Elsevier, vol. 25(3), pages 373-405, June.
    2. Daniel, Kent & Hirshleifer, David & Teoh, Siew Hong, 2002. "Investor psychology in capital markets: evidence and policy implications," Journal of Monetary Economics, Elsevier, vol. 49(1), pages 139-209, January.
    3. Svetlozar Rachev & Stoyan Stoyanov & Stefan Mittnik & Frank J. Fabozzi, 2017. "Behavioral Finance -- Asset Prices Predictability, Equity Premium Puzzle, Volatility Puzzle: The Rational Finance Approach," Papers 1710.03211, arXiv.org.
    4. Nielsen, Carsten Krabbe, 2008. "On rationally confident beliefs and rational overconfidence," Mathematical Social Sciences, Elsevier, vol. 55(3), pages 381-404, May.
    5. Lee, Charles M. C., 2001. "Market efficiency and accounting research: a discussion of 'capital market research in accounting' by S.P. Kothari," Journal of Accounting and Economics, Elsevier, vol. 31(1-3), pages 233-253, September.

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    Keywords

    market rationality; volatility;

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