Belief Heterogeneity And Survival In Incomplete Markets

In complete markets economies (Sandroni [15]), or in economies with Pareto optimal outcomes (Blume and Easley [9]), the market selection hypothesis holds, as long as traders have identical discount factors. Traders who survive must have beliefs that merge with the truth. The authors show that in incomplete markets, regardless of traders' discount factors, the market selects for a range of beliefs, at least some of which do not merge with the truth. They also show that impatient traders with incorrect beliefs can survive and that these incorrect beliefs impact prices. These beliefs may be chosen so that they are far from the truth.