Market Selection with Idiosyncratic Uncertainty

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Title: Market Selection with Idiosyncratic Uncertainty
Author: Sihvonen, Markus
Series: Journal of Economic Theory
Series volume: 182
Series number: July
Year of publication: 2019
Publication date: 23.4.2019
Page range: 142-160
Subject (yso): taloustieteet
JEL: D53; D83; G12
Other keywords: Market Selection Hypothesis; Asset Pricing; Heterogeneous Beliefs; General Equilibrium
Abstract: I analyze the survival probabilities of different types of agents in a general equilibrium model with disagreement over idiosyncratic uncertainties. I find that such biases create a separation between individual and group level survival: even when the survival probability of a single irrational agent tends to zero, these agents may still succeed as a whole. Effectively the irrational agent population can survive due to a vanishingly small group of increasingly rich agents. Disagreement over idiosyncratic uncertainties distorts savings decisions and interest rates, but idiosyncratic risks are not priced. Simulations confirm that the limiting results are relevant when the population of irrational agents is large.

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