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Frontiers of Economics in China

Front Econ Chin    2013, Vol. 8 Issue (3) : 293-308     DOI: 10.3868/s060-002-013-0016-5
research-article |
Do Irrational Investors Destabilize?
Hao Li()
Department of Economics, University of British Columbia, Vancouver, BC V6T 1Z8, Canada
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Abstract

In a financial market where all investors have valuable private information, full rationality requires that investors have an unlimited ability of figuring out the equilibrium model. Instead, I assume that due to a lack of knowledge or experience, some investors do not know the equilibrium model and use only their private information in forming their demand. By investigating the investment behavior of these “boundedly rational” investors and contrasting it with that of the rational ones, I find that in a market where the two kinds of investors coexist, it is the boundedly rational investors who contribute to price stability. The welfare implication is that, although each investor benefits from conditioning his asset demand on the information transmitted by the equilibrium price, it can happen that all investors lose by doing so because the equilibrium price becomes too volatile.

Keywords irrational investor      destabilize      equilibrium      stability     
Corresponding Authors: Hao Li,Email:hao.li@ubc.ca   
Issue Date: 05 September 2013
 Cite this article:   
Hao Li. Do Irrational Investors Destabilize?[J]. Front Econ Chin, 2013, 8(3): 293-308.
 URL:  
http://journal.hep.com.cn/fec/EN/10.3868/s060-002-013-0016-5
http://journal.hep.com.cn/fec/EN/Y2013/V8/I3/293
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