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The Limits of Investor Behavior

Mark Loewenstein and Gregory A. Willard

Journal of Finance, 2006, vol. 61, issue 1, 231-258

Abstract: Many models use noise trader risk and corresponding violations of the Law of One Price to explain pricing anomalies, but include a storage technology in perfectly elastic supply or unlimited asset liability. Storage allows aggregate consumption risk to differ from exogenous fundamental risk, but using aggregate consumption as a factor for asset returns can make noise trader risk superfluous. Using (i) limited asset liability and limited storage withdrawals, or (ii) an endogenous locally riskless interest rate eliminates violations of the Law of One Price. Our main results use only budget equations and market clearing, and require virtually no assumptions about behavior.

Date: 2006
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https://doi.org/10.1111/j.1540-6261.2006.00835.x

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