Discussion paper

DP16335 Do the Effects of Individual Behavioral Biases Cancel Out?

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.

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Citation

Uppal, R and H Bhamra (eds) (2021), “DP16335 Do the Effects of Individual Behavioral Biases Cancel Out?”, CEPR Press Discussion Paper No. 16335. https://cepr.org/publications/dp16335