Beauty Contests, Bubbles and Iterated Expectations in Asset Markets

Franklin Allen (), Stephen Morris () and Hyun Song Shin
Additional contact information
Hyun Song Shin: London School of Economics

No 1406, Cowles Foundation Discussion Papers from Cowles Foundation, Yale University

Abstract: In a financial market where traders are risk averse and short lived, and prices are noisy, asset prices today depend on the average expectation today of tomorrow's price. Thus (iterating this relationship) the date 1 price equals the date 1 average expectation of the date 2 average expectation of the date 3 price. This will not in general equal the date 1 average expectation of the date 3 price. We show how this failure of the law of iterated expectations for average belief can help understand the role of higher order beliefs in a fully rational asset pricing model and explain over-reaction to (noisy) public information.

Keywords: Beauty Contests; Bubbles and iterated expectations in Asset Markets (search for similar items in EconPapers)
JEL-codes: E4 G12 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn
Date: 2003-03
View list of references View citations in EconPapers

Published in Review of Financial Studies (2006), 19: 719-752

Downloads: (external link)
http://cowles.econ.yale.edu/P/cd/d14a/d1406.pdf (application/pdf)

Related works:
Working Paper: Beauty Contests, Bubbles and Iterated Expectations in Asset Markets (2003)
Working Paper: Beauty Contests, Bubbles and Iterated Expectations in Asset Markets (2004)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: http://EconPapers.repec.org/RePEc:cwl:cwldpp:1406

Ordering information: This working paper can be ordered from
Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA
The price is None.

Access Statistics for this paper

More papers in Cowles Foundation Discussion Papers from Cowles Foundation, Yale University
Address: Yale University, Box 208281, New Haven, CT 06520-8281 USA
Contact information at EDIRC.
Series data maintained by Glena Ames ().