Review of Finance Advance Access originally published online on October 3, 2008
Review of Finance 2009 13(4):693-725; doi:10.1093/rof/rfn022
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Bounded Rationality and Asset Pricing with Intermediate Consumption*
University of Geneva and Swiss Finance Institute
We consider a pure exchange economy with incomplete information. Some agents display learning bias and over- or under-react to the arrival of new information. We show under which conditions biased agents survive over a finite horizon. We also study the distribution of irrational agents consumption shares. Irrational agents have a signiÞcant consumption share in the economy when (i) shocks are less persistent (ii) risk aversion is high (iii) volatility of aggregate consumption is high. We also show that agents impact on prices is increasing in their consumption share and conclude that biased agents can signiÞcantly influence equilibrium quantities.
JEL Classification: G12
* I would like to thank Peter Bossaert (the editor) and two anonymous referees as well as Jérome Detemple, Pascal Francois, Julien Hugonnier, Eric Jacquier and participants at the 2003 French Finance Association Meeting, 2004 SCSE, 2004 EFMA meeting, 2004 Bachelier world congress, Stochastic Finance 2004 for useful comments. Financial support from IFM2 and the Swiss National Science Foundation under grant 8210-064770 is gratefully acknowledged.