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Do Markets Prove Pessimists Right?

Author

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  • Jürgen Eichberger
  • Ani Guerdjikova

Abstract

We study how ambiguity and ambiguity attitudes affect asset prices when consumers form their expectations based on past observations. In an overlapping generations economy with risk‐neutral yet ambiguity‐sensitive consumers, we describe limiting asset prices depending on the proportion of investor types. We then study the evolution of consumer‐type shares. With long memory, the market does not select for ambiguity neutrality. Whenever perceived ambiguity is sufficiently small, but positive, only pessimists survive and determine prices in the limit. With one‐period memory, equilibrium prices are determined by Bayesians. Yet, the average price of the risky asset is lower than its fundamental value.

Suggested Citation

  • Jürgen Eichberger & Ani Guerdjikova, 2018. "Do Markets Prove Pessimists Right?," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 59(4), pages 2259-2295, November.
    • Handle: RePEc:wly:iecrev:v:59:y:2018:i:4:p:2259-2295
    DOI: 10.1111/iere.12336
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    Cited by:

    1. Ani Guerdjikova & John Quiggin, 2018. "Heuristic Modes of Decision Making and Survival in Financial Markets," Post-Print hal-02086267, HAL.
    2. Burkhard C. Schipper, 2021. "The evolutionary stability of optimism, pessimism, and complete ignorance," Theory and Decision, Springer, vol. 90(3), pages 417-454, May.
    3. Ani Guerdjikova & John Quiggin, 2018. "Intertemporal Portfolio Choice with Incorrect Beliefs and Aversion to Surprise," Post-Print hal-02086151, HAL.
    4. Péter Bayer & Ani Guerdjikova, 2020. "Optimism leads to optimality: Ambiguity in network formation," Working Papers hal-03005107, HAL.
    5. Adam Dominiak & Ani Guerdjikova, 2021. "Special Issue on Ambiguity and Strategic Interactions in Honor of Jürgen Eichberger," Theory and Decision, Springer, vol. 90(3), pages 301-307, May.
    6. Dominiak, Adam & Eichberger, Jürgen, 2021. "Games in context: Equilibrium under ambiguity for belief functions," Games and Economic Behavior, Elsevier, vol. 128(C), pages 125-159.

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