Unrealized arbitrage opportunities in naive equilibria with non-Bayesian belief processes

Alexander Zimper

Mathematical Social Sciences, 2023, vol. 125, issue C, 27-41

Abstract: A non-Bayesian decision maker forms posterior beliefs through an – ever so slightly – violation of Bayes’ rule. A naive equilibrium is a competitive equilibrium for a multiperiod complete markets economy such that every economic agent – Bayesian or non-Bayesian – assumes that all economic agents are Bayesian decision makers. If all agents are indeed Bayesian decision makers, the naive equilibrium coincides with the standard concept of an arbitrage-free equilibrium for which dynamic price ratios are comprehensively pinned down as the equilibrium price ratios of Arrow–Debreu securities in a static economy. If at least one agent is a non-Bayesian decision maker, however, some equilibrium price ratios will change over time. These changing price ratios imply the existence of unrealized dynamic arbitrage opportunities in a naive equilibrium with non-Bayesian decision makers.

Keywords: Non-Bayesian updating; Dynamic inconsistency; Bounded rationality; Representative agent; Dynamic arbitrage opportunities (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eee:matsoc:v:125:y:2023:i:c:p:27-41

DOI: 10.1016/j.mathsocsci.2023.07.001

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