Affective Utilities: A Rational Theory of Optimistic Bias in Asset Markets

Anat Bracha and Donald J. Brown ()
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Donald J. Brown: Dept. of Economics, Yale University, https://economics.yale.edu/people/emeritus/donald-j-brown

No 1898R, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University

Abstract: The equilibrium prices in asset markets, as stated by Keynes (1930): "...will be fixed at the point at which the sales of the bears and the purchases of the bulls are balanced." We propose a descriptive theory of finance explicating Keynes' claim that the prices of assets today equilibrate the optimism and pessimism of bulls and bears regarding the payoffs of assets tomorrow. This equilibration of optimistic and pessimistic beliefs of investors is a consequence of investors maximizing affective utilities subject to budget constraints defined by market prices and investor's income. The set of affective utilities is a new class of non-expected utility functions representing the attitudes of investors for optimism or pessimism, defined as the composition of the investor's attitudes for risk and her attitudes for ambiguity. Bulls and bears are defined respectively as optimistic and pessimistic investors.

Keywords: Risk; Ambiguity; Irrational Exuberance (search for similar items in EconPapers)
JEL-codes: D81 G02 G11 (search for similar items in EconPapers)
Pages: 12 pages
Date: 2013-06, Revised 2014-06
New Economics Papers: this item is included in nep-hpe and nep-upt
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