Unbiased Disagreement in financial markets, waves of pessimism and the risk return tradeoff

Napp, Clotilde; Jouini, Elyès

Napp, Clotilde; Jouini, Elyès (2011), Unbiased Disagreement in financial markets, waves of pessimism and the risk return tradeoff, Review of Finance, 15, 3, p. 575-601. http://dx.doi.org/10.1093/rof/rfq002

Type

Article accepté pour publication ou publié

External document link

http://halshs.archives-ouvertes.fr/halshs-00488481/fr/

Date

2011

Journal name

Review of Finance

Volume

Number

Publisher

Oxford University Press

Pages

575-601

Abstract (EN)

Can investors with irrational beliefs be neglected as long as they are rational on average ? Do their trades cancel out with no consequences on prices, as implicitly assumed by traditional models? We consider a model with irrational investors, who are rational on average. We obtain waves of pessimism and optimism that lead to countercyclical market prices of risk and procyclical risk-free rates. The variance of the state price density is greatly increased. The long run risk-return relation is modified; in particular, the long run market price of risk might be higher than both the instantaneous and the rational ones.

Subjects / Keywords

rational on average; irrational investors

JEL

D53 - Financial Markets
G12 - Asset Pricing; Trading Volume; Bond Interest Rates