 Beauty contest, bounded rationality, and sentiment pricing dynamicsHanchao Liang, Chunpeng Yang and Chuangqun Cai Economic Modelling, 2017, vol. 60, issue C, 71-80 Abstract: We present a dynamic asset pricing model that incorporates investor sentiment, bounded rationality and higher-order expectations to study how these factors affect asset pricing equilibrium. In the model, we utilize a two-period trading market and investors make decisions based on the heterogeneous expectations principle and the “sparsity-based bounded rational” sentiment. We find that bounded rationality results in mispricing and reduces it in next period. Investor sentiment produces more significant effects than private signals, optimistic investor sentiment increases hedging demand, thus causing prices to soar. Higher-order investors are more rational and attentive to the strategies of other participants rather than private signals. This model also derives the dampening effect of higher-order expectations to price volatility and the heterogeneity expectation depicts inconsistent investor behavior in financial markets. In the model, investors' expectations about future price is distorted by their sentiment and bounded rationality, so they obtain a biased mean from the signal extraction. Keywords: Higher-order expectations; Investor sentiment; Bounded rationality; Dynamic pricing equilibrium (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:60:y:2017:i:c:p:71-80 DOI: 10.1016/j.econmod.2016.09.010 Access Statistics for this article Economic Modelling is currently edited by S. Hall and P. Pauly More articles in Economic Modelling from Elsevier |
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