If You're So Smart, Why Aren't You Rich?
Belief Selection in Complete and Incomplete
Markets
Abstract: This paper provides an analysis of the asymptotic properties of
Pareto optimal consumption allocations in a stochastic general equilibrium
model with heterogeneous consumers. In particular we investigate the market
selection hypothesis, that markets favor traders with more accurate beliefs.
We show that in any Pareto optimal allocation whether each consumer van-
ishes or survives is determined entirely by discount factors and beliefs. Since
equilibrium allocations in economies with complete markets are Pareto opti-
mal, our results characterize the limit behavior of these economies. We show
that, all else equal, the market selects for consumers who use Bayesian learn-
ing with the truth in the support of their prior and selects among Bayesians
according to the size of their parameter space. Finally, we show that in
economies with incomplete markets these conclusions may not hold. With
incomplete markets payo
functions can matter for long run survival, and
functions can matter for long run survival, and
the market selection hypothesis fails.
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