Unbiased Disagreement in financial markets, waves of pessimism and the risk return tradeoff

Elyès Jouini (1) , Clotilde Napp (2)

1 CEREMADE - CEntre de REcherches en MAthématiques de la DEcision
2 DRM - Dauphine Recherches en Management

Can investors with irrational beliefs be neglected as long as they are rational on average ? Do their trades cancel out with no consequences on prices, as implicitly assumed by traditional models? We consider a model with irrational investors, who are rational on average. We obtain waves of pessimism and optimism that lead to countercyclical market prices of risk and procyclical risk-free rates. The variance of the state price density is greatly increased. The long run risk-return relation is mod- i…ed; in particular, the long run market price of risk might be higher than both the instantaneous and the rational ones.

Mots clés: irrational investors; rational on average

Domaines: Economies et finances

Elyès Jouini, Clotilde Napp. Unbiased Disagreement in financial markets, waves of pessimism and the risk return tradeoff. Review of Finance, 2010, (to appear). ⟨halshs-00488481⟩