Market selection with learning and catching up with the Joneses

TL;DR

This paper investigates how heterogeneous agents with diverse beliefs, preferences, and learning behaviors influence market selection, equilibrium interest rates, and risk prices in complete financial markets using advanced probabilistic techniques.

Contribution

It introduces new methods based on Strassen's law to analyze long-term dynamics and explicitly characterizes agents' survival indices depending on their traits.

Findings

Agents' survival depends on their characteristics

Long-run interest rate behavior is characterized

Market risk prices are influenced by heterogeneity

Abstract

We study the market selection hypothesis in complete financial markets, populated by heterogeneous agents. We allow for a rich structure of heterogeneity: individuals may differ in their beliefs concerning the economy, information and learning mechanism, risk aversion, impatience and 'catching up with Joneses' preferences. We develop new techniques for studying the long-run behavior of such economies, based on the Strassen's functional law of iterated logarithm. In particular, we explicitly determine an agent's survival index and show how the latter depends on the agent's characteristics. We use these results to study the long-run behavior of the equilibrium interest rate and the market price of risk.