DP16335 Do the Effects of Individual Behavioral Biases Cancel Out?
|Author(s):||Harjoat Singh Bhamra, Raman Uppal|
|Publication Date:||July 2021|
|Keyword(s):||aggregate growth, behavioral finance, money market, Stochastic discount factor|
|JEL(s):||E03, E44, G02, G11, G41|
|Programme Areas:||Financial Economics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=16335|
A major criticism of behavioral economics is that it has not shown that the idiosyncratic biases of individual investors lead to aggregate effects. We construct a model of a general-equilibrium production economy with a large number of firms and investors. Investors' beliefs about stock returns are determined endogenously based on their psychological distances from firms; consequently, investors are optimistic about some stocks and pessimistic about others. We consider two examples: one where portfolio errors cancel out and the other in which the behavioral biases cancel out when aggregated across investors. We show asset prices and macroeconomic aggregates are still distorted.