Title: Perfect Forecasting, Behavioral Heterogeneities, and Asset Prices
Abstract: When agents are allowed to switch between financial mediators, asset prices may behave in a nonergodic manner if their interactive complementarities are too strong. This view stands in contrast to the rational expectations paradigm, which assumes that agents make no systematic errors in predicting the future. The rational expectations paradigm is one of the tenets in at least three strands of the literature on financial markets. First, much of the finance literature has used the rational expectations paradigm to substitute market equilibrium conditions with no-arbitrage conditions. In this context, asset prices are assumed to follow an exogenously given stochastic process to which agents' expectations and their trading activities adjust without any feedback on the process. The literature on financial markets has responded to the dissatisfaction with the rational expectations paradigm with different lines of research, often carried out simultaneously. Models with heterogeneous boundedly rational agents generally have three structural elements in common. First, a temporary equilibrium map determines asset prices in each period, given the characteristics of investors such as preferences and subjective beliefs regarding the future evolution of markets. Second, forecasting rules stipulate the way in which agents form and update these beliefs. Third, a model for exogenous perturbations captures all influences that are not modeled explicitly, such as dividend payments, random endowments, or noise-traders' activities.
Publication Year: 2009
Publication Date: 2009-01-01
Language: en
Type: book-chapter
Indexed In: ['crossref']
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Cited By Count: 6
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