The Less the Better: Naive Traders and Asset Prices

“In this paper I study a simple exchange economy where two traders repeatedly exchange two long-lived assets. My focus is on how assets are priced in the long-run depending on agents' behavior when nobody in the market knows the true probability of future events. I show how, if traders have heterogeneous and incorrect beliefs and use simple consumption and investment rules, in the limit in which they devote to investment all their wealth, the resulting prices converge to the true probabilities of the underlying process, that is, the fully rational pricing. This is in contrast with what happens when traders with the same heterogeneous (and incorrect) beliefs maximize a discounted utility over an infinite horizon under rational price expectations: in that case prices reflect only the beliefs of the most accurate agent”.