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

Abstract : 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.
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Submitted on : Wednesday, June 2, 2010 - 10:17:07 AM
Last modification on : Wednesday, November 17, 2021 - 12:27:12 PM
Long-term archiving on: : Friday, September 17, 2010 - 12:04:20 PM

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Elyès Jouini, Clotilde Napp. Unbiased Disagreement in financial markets, waves of pessimism and the risk return tradeoff. Review of Finance, Oxford University Press (OUP): Policy F - Oxford Open Option D, 2010, (to appear). ⟨halshs-00488481⟩

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