Efficient markets and Bayes' rule

Alvaro Sandroni*

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

9 Scopus citations

Abstract

A series of financial anomalies motivated the development of new theories that modify the rational expectations ideal. Two possibilities have been systematically explored. The literature on behavioral finance relaxes the assumption that agents form beliefs according to the laws of probability and assume, instead, that simpler heuristic rules are used. Another stream of the literature assumes that agents process information according to Bayes' rule, but do not posses sufficient information to know the true data generating process. In this paper, Bayesian and Behavioral agents coexist and trade in a standard dynamic asset pricing model. A long-standing conjecture is demonstrated. It is shown that, under suitable assumptions, Bayesian agents drive Behavioral, non-Bayesian agents out of the market. Hence, asset prices are eventually determined under the Bayesian paradigm.

Original languageEnglish (US)
Pages (from-to)741-764
Number of pages24
JournalEconomic Theory
Volume26
Issue number4
DOIs
StatePublished - Nov 1 2005

Keywords

  • Bayes' rule
  • Wealth accumulation

ASJC Scopus subject areas

  • Economics and Econometrics

Fingerprint

Dive into the research topics of 'Efficient markets and Bayes' rule'. Together they form a unique fingerprint.

Cite this