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Can irrational investors survive in the long run? The role of generational type transmission

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  • Condie, Scott S.
  • Phillips, Kerk L.

Abstract

This paper considers whether expected utility maximizers who have incorrect beliefs can survive as controllers of a significant portion of market wealth in the long run. Unlike infinitely-lived agent models, where this is not the case, we consider a model with successive generations of investors. Each generation inherits wealth and investor type from the previous generation. We show that if rational parents produce only rational children, and irrational parents always produce only irrational children, then the results from the infinitely-lived setup carry through. However, if parents of one type can produce even a small fraction of children of the other type, then irrational investors will always control a non-vanishing portion of total wealth. Hence, understanding the exact nature of the transmission of incorrect beliefs is key to understanding long-run market prices.

Suggested Citation

  • Condie, Scott S. & Phillips, Kerk L., 2016. "Can irrational investors survive in the long run? The role of generational type transmission," Economics Letters, Elsevier, vol. 139(C), pages 40-42.
    • Handle: RePEc:eee:ecolet:v:139:y:2016:i:c:p:40-42
    DOI: 10.1016/j.econlet.2015.12.008
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    References listed on IDEAS

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    1. Armen A. Alchian, 1950. "Uncertainty, Evolution, and Economic Theory," Journal of Political Economy, University of Chicago Press, vol. 58(3), pages 211-211.
    2. Leonid Kogan & Stephen A. Ross & Jiang Wang & Mark M. Westerfield, 2006. "The Price Impact and Survival of Irrational Traders," Journal of Finance, American Finance Association, vol. 61(1), pages 195-229, February.
    3. Hongjun Yan, 2008. "Natural Selection in Financial Markets: Does It Work?," Management Science, INFORMS, vol. 54(11), pages 1935-1950, November.
    4. Hongjun Yan, 2008. "Natural Selection in Financial Markets: Does It Work?," Management Science, INFORMS, vol. 54(11), pages 1935-1950, November.
    5. Alvaro Sandroni, 2000. "Do Markets Favor Agents Able to Make Accurate Predicitions?," Econometrica, Econometric Society, vol. 68(6), pages 1303-1342, November.
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    Cited by:

    1. Kim Gannon & Hanzhe Zhang, 2020. "An Evolutionary Justification for Overconfidence," Economics Bulletin, AccessEcon, vol. 40(3), pages 2494-2504.

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    More about this item

    Keywords

    Irrationality; Financial markets; Natural selection; Evolutionary dynamics; Market dynamics;
    All these keywords.

    JEL classification:

    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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