Market Selection / Leonid Kogan, Stephen Ross, Jiang Wang, Mark M. Westerfield.

By:

Kogan, Leonid

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Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w15189.Publication details: Cambridge, Mass. National Bureau of Economic Research 2009.Description: 1 online resource: illustrations (black and white)Subject(s):

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Abstract: The hypothesis that financial markets punish traders who make relatively inaccurate forecasts and eventually eliminate the effect of their beliefs on prices is of fundamental importance to the standard modeling paradigm in asset pricing. We establish necessary and sufficient conditions for agents making inferior forecasts to survive and to affect prices in the long run in a general setting with minimal restrictions on endowments, beliefs, or utility functions. We show that the market selection hypothesis is valid for economies with bounded endowments or bounded relative risk aversion, but it cannot be substantially generalized to a broader class of models. Instead, survival is determined by a comparison of the forecast errors to risk attitudes. The price impact of inaccurate forecasts is distinct from survival because price impact is determined by the volatility of traders' consumption shares rather than by their level. Our results also apply to economies with state-dependent preferences, such as habit formation.

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Item type	Home library	Collection	Call number	Status	Date due	Barcode	Item holds
Working Paper	Biblioteca Digital	Colección NBER	nber w15189 (Browse shelf(Opens below))	Not For Loan

Total holds: 0

July 2009.

The hypothesis that financial markets punish traders who make relatively inaccurate forecasts and eventually eliminate the effect of their beliefs on prices is of fundamental importance to the standard modeling paradigm in asset pricing. We establish necessary and sufficient conditions for agents making inferior forecasts to survive and to affect prices in the long run in a general setting with minimal restrictions on endowments, beliefs, or utility functions. We show that the market selection hypothesis is valid for economies with bounded endowments or bounded relative risk aversion, but it cannot be substantially generalized to a broader class of models. Instead, survival is determined by a comparison of the forecast errors to risk attitudes. The price impact of inaccurate forecasts is distinct from survival because price impact is determined by the volatility of traders' consumption shares rather than by their level. Our results also apply to economies with state-dependent preferences, such as habit formation.