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Market Selection and Welfare in a Multi-asset Economy

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  • Yurii Fedyk
  • Christian Heyerdahl-Larsen
  • Johan Walden

Abstract

We analyze the performance of irrational investors, who mistake expected returns of assets in a multi-asset economy. Mistakes by probabilistically unsophisticated investors that a priori seem small lead to severe underperformance compared with rational investors, under general conditions. Our results contrast with previous studies of single-asset economies, which find modest underperformance by irrational investors. In a calibration, an irrational investor who mistakes expected returns by 20% loses almost 95% of his consumption and wealth in about 25 years. The welfare cost of this underperformance is significant, about 40% of the total wealth in the economy. Copyright 2013, Oxford University Press.

Suggested Citation

  • Yurii Fedyk & Christian Heyerdahl-Larsen & Johan Walden, 2013. "Market Selection and Welfare in a Multi-asset Economy," Review of Finance, European Finance Association, vol. 17(3), pages 1179-1237.
    • Handle: RePEc:oup:revfin:v:17:y:2013:i:3:p:1179-1237
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    File URL: http://hdl.handle.net/10.1093/rof/rfs009
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    Cited by:

    1. Bernstein, Asaf & Billings, Stephen B. & Gustafson, Matthew T. & Lewis, Ryan, 2022. "Partisan residential sorting on climate change risk," Journal of Financial Economics, Elsevier, vol. 146(3), pages 989-1015.
    2. Ehling, Paul & Gallmeyer, Michael & Heyerdahl-Larsen, Christian & Illeditsch, Philipp, 2018. "Disagreement about inflation and the yield curve," Journal of Financial Economics, Elsevier, vol. 127(3), pages 459-484.
    3. Antoine Kopp & Rebecca Westphal & Didier Sornette, 2022. "Agent-based model generating stylized facts of fixed income markets," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 17(4), pages 947-992, October.
    4. Buss, Adrian & Dumas, Bernard & Uppal, Raman & Vilkov, Grigory, 2016. "The intended and unintended consequences of financial-market regulations: A general-equilibrium analysis," Journal of Monetary Economics, Elsevier, vol. 81(C), pages 25-43.
    5. He, Xue-Zhong & Shi, Lei, 2017. "Index portfolio and welfare analysis under heterogeneous beliefs," Journal of Banking & Finance, Elsevier, vol. 75(C), pages 64-79.
    6. Han, Kookyoung, 2021. "Self-enforcement, heterogeneous agents, and long-run survival," Economics Letters, Elsevier, vol. 204(C).
    7. Giulio Bottazzi & Pietro Dindo & Daniele Giachini, 2018. "Long-run heterogeneity in an exchange economy with fixed-mix traders," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 66(2), pages 407-447, August.
    8. Hansen, Simon Lysbjerg, 2015. "Cross-sectional asset pricing with heterogeneous preferences and beliefs," Journal of Economic Dynamics and Control, Elsevier, vol. 58(C), pages 125-151.
    9. Harjoat S. Bhamra & Raman Uppal, 2014. "Asset Prices with Heterogeneity in Preferences and Beliefs," The Review of Financial Studies, Society for Financial Studies, vol. 27(2), pages 519-580.
    10. Johan Walden & Christian Heyerdahl-Larsen, 2015. "Efficiency and Distortions in a Production Economy with Heterogeneous Beliefs," 2015 Meeting Papers 124, Society for Economic Dynamics.
    11. Buss, Adrian & Vilkov, Grigory & Uppal, Raman, 2018. "The Implications of Financial Innovation for Capital Markets and Household Welfare," CEPR Discussion Papers 13137, C.E.P.R. Discussion Papers.
    12. Kogan, Leonid & Ross, Stephen A. & Wang, Jiang & Westerfield, Mark M., 2017. "Market selection," Journal of Economic Theory, Elsevier, vol. 168(C), pages 209-236.
    13. Hai-Chuan Xu & Wei Zhang & Xiong Xiong & Wei-Xing Zhou, 2014. "Wealth Share Analysis with “Fundamentalist/Chartist” Heterogeneous Agents," Abstract and Applied Analysis, Hindawi, vol. 2014, pages 1-11, May.
    14. Shi, Lei, 2016. "Consumption-based CAPM with belief heterogeneity," Journal of Economic Dynamics and Control, Elsevier, vol. 65(C), pages 30-46.
    15. Zongxia Liang & Qi Ye, 2024. "Despite Absolute Information Advantages, All Investors Incur Welfare Loss," Papers 2405.08822, arXiv.org.

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