Asset pricing with imperfect foresight

Is it plausible to assume that securities prices can be right if choices that generate those prices are demonstrably wrong?


We investigate the above question in the context of one of the canonical models of asset pricing, where agents with quadratic preferences are allowed to re-trade a limited set of securities for a number of periods, after which these securities expire, and agents consume their liquidation values. A key assumption in the literature is that agents have perfect foresight: they correctly predict prices in all future contingencies. We show that, under myopia, prices generically are as if agents had perfect foresight, even if agents use no foresight. Yet their choices are “wrong,” because agents incorrectly believe that they will never re-trade. In an experiment, we have confirmed that prices and choices are indeed as predicted by the myopic equilibrium. Evidently, participants react to imperfect foresight by not forecasting whatsoever, but nevertheless choosing rationally given their endowments.

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