Financial market equilibrium with bounded awareness

A. Guerdjikova and John Quiggin

Working Papers from Grenoble Applied Economics Laboratory (GAEL)

Abstract: We consider an infinite-horizon economy with differential awareness in the form of coarsening. For such economies, we propose an equilibrium concept hich requires agents' consumption to be measurable w.r.t. the individual awareness partitions. We illustrate how the obtained equilibrium allocations observationally differ from those in economies with full awareness. In particular, economies with differential awareness can exhibit (i) lack of insurance against idiosyncratic risk; (ii) partial insurance against aggregate risk; (iii) biased state prices even when beliefs are correct and (iv) overpricing of assets which pay on events with low aggregate payoffs. We next adapt the results of Guerdjikova and Quiggin (2019 a) to show that agents with different levels of awareness can survive and influence prices in the limit. In this sense, the characteristics identified above would persist in the long-run. Moreover, differential awareness can lead to belief heterogeneity even in the limit. This is in contrast with the classical result of Blume and Easley (2006) stating that only agents with beliefs closest to the truth can survive. Finally, we examine the welfare implications of bounded awareness in the sense of Gilboa, Samuelson and Schmeidler (2014) and Blume et al. (2018). If an increase in awareness comes at the cost of wrong beliefs over the larger state-space, bounded awareness can be welfare-improving, both from an individual and from a social point of view. In this sense, heuristics which constrain agents to invest in "assets they understand" can be ecologically rational in the sense of Gigerenzer (2007) and improve the stability of financial markets by allowing a larger set of agents to survive.

Keywords: FINANCIAL MARKET; BOUNDED AWARENESS; DECISION MAKING (search for similar items in EconPapers)
JEL-codes: D53 D81 D83 (search for similar items in EconPapers)
Date: 2020
New Economics Papers: this item is included in nep-mic
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
https://gael.univ-grenoble-alpes.fr/sites/default/ ... 2020/gael2020-10.pdf (application/pdf)

Related works:
Working Paper: Financial Market Equilibrium with Bounded Awareness 1 (2023)
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: https://EconPapers.repec.org/RePEc:gbl:wpaper:2020-10

Access Statistics for this paper

More papers in Working Papers from Grenoble Applied Economics Laboratory (GAEL) Contact information at EDIRC.
Bibliographic data for series maintained by Adrien Hervouet ().