 Internal rationality, imperfect market knowledge and asset pricesJournal of Economic Theory, 2011, vol. 146, issue 3, 1224-1252 Abstract: We present a decision theoretic framework in which agents are learning about market behavior and that provides microfoundations for models of adaptive learning. Agents are 'internally rational', i.e., maximize discounted expected utility under uncertainty given dynamically consistent subjective beliefs about the future, but agents may not be 'externally rational', i.e., may not know the true stochastic process for payoff relevant variables beyond their control. This includes future market outcomes and fundamentals. We apply this approach to a simple asset pricing model and show that the equilibrium stock price is then determined by investors[modifier letter apostrophe] expectations of the price and dividend in the next period, rather than by expectations of the discounted sum of dividends. As a result, learning about price behavior affects market outcomes, while learning about the discounted sum of dividends is irrelevant for equilibrium prices. Stock prices equal the discounted sum of dividends only after making very strong assumptions about agents[modifier letter apostrophe] market knowledge. Keywords: Learning; Internal; rationality; Consumption; based; asset; pricing (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:jetheo:v:146:y:2011:i:3:p:1224-1252 Access Statistics for this article Journal of Economic Theory is currently edited by A. Lizzeri and K. Shell More articles in Journal of Economic Theory from Elsevier |
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