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Bounded Rationality and Asset Pricing

Author

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  • Tony Berrada

    (University of Lausanne and Swiss Finance Institute)

Abstract

We consider a pure exchange economy with incomplete information. Some agents in the economy display learning bias and over- or underreact to the arrival of new information. We study, by simulation, the distribution of irrational agents’ consumption shares. We find that over a reasonable horizon (50 years) under- or over-reaction has little impact on an agent’s consumption share, when parameters of the model are chosen to fit aggregate consumption data in the US. We also show that agents’impact on prices is increasing in their consumption share and conclude that biased agents can significantly influence equilibrium quantities.

Suggested Citation

  • Tony Berrada, 2003. "Bounded Rationality and Asset Pricing," Swiss Finance Institute Research Paper Series 06-07, Swiss Finance Institute, revised Jun 2006.
  • Handle: RePEc:chf:rpseri:rp0607
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    File URL: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=910214
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    References listed on IDEAS

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    Cited by:

    1. Hugonnier, Julien, 2012. "Rational asset pricing bubbles and portfolio constraints," Journal of Economic Theory, Elsevier, vol. 147(6), pages 2260-2302.
    2. Bernard Dumas & Alexander Kurshev & Raman Uppal, 2009. "Equilibrium Portfolio Strategies in the Presence of Sentiment Risk and Excess Volatility," Journal of Finance, American Finance Association, vol. 64(2), pages 579-629, April.
    3. Hongjun Yan, 2008. "Natural Selection in Financial Markets: Does It Work?," Management Science, INFORMS, vol. 54(11), pages 1935-1950, November.
    4. Dumas, Bernard J & Kurshev, Alexander & Uppal, Raman, 2005. "What Can Rational Investors Do About Excessive Volatility and Sentiment Fluctuations?," CEPR Discussion Papers 5367, C.E.P.R. Discussion Papers.

    More about this item

    Keywords

    Bounded rationality; incomplete information; equilibrium;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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