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Working Papers

Working Papers

Survival in Speculative Markets. LEM Working Paper 2015/32. SLIDES.
In a stochastic exchange economy where, due to heterogeneity, agents engage in speculative trade, I investigate the Market Selection Hy- pothesis that speculation rewards the agent with the most accurate beliefs. Assuming that markets are complete, I derive sufficient conditions for survival in terms of saving and portfolio decisions and use them to show that the Market Selection Hypothesis fails generically. In particular, when agents have Epstein-Zin preferences, beliefs heterogeneity may persist in the long- run or speculation may cause the agent with the most accurate beliefs to vanish. Failures occur because portfolio average returns are shown to depend not only on accuracy but also on risk preferences, through the comparison with the growth-optimal portfolio. Failures do not occur in bounded CRRA economies because, due to the interdependence of relative risk aversion and intertemporal elasticity of substitution, portfolio returns not related to accuracy are compensated by the component of saving that responds to uncertainty. (Journal of Economic Theory, revise and resubmit)

Drift criteria for persistence of discrete stochastic processes on the line, with Giulio Bottazzi. LEM Working Paper 2015/26.
We provide sufficient conditions for the persistence or transience of stochastic processes on the line based on the sign of the conditional drift. Our findings extend previous results in the literature to the large class of discrete time processes with bounded increments.

Work in Progress

The Wisdom of the Crowd Revisited, with Filippo Massari
The Wisdom of the Crowd applied to financial markets states that asset prices, an average of agents' beliefs, are more accurate than individual beliefs. However, a market selection argument implies that prices eventu- ally reflect only the beliefs of the most accurate agent. In this paper, we show how to reconcile these alternative points of view. In markets in which beliefs partially incorporate equilibrium prices, a dynamic Wisdom of the Crowd holds. Market participation increases agents' accuracy, and equilib- rium prices are more accurate than the most accurate agent in isolation.

A Model of Market Sentiment, with Giulio Bottazzi e Daniele Giachini
Several empirical studies show that financial returns tend to underreact to news in the short-run and overreact in the long-run, generating short- term momentum and long-term reversal. The behavioral finance literature links the emergence of underreaction and overreaction to investors cogni- tive biases in the processing of new information. In this paper we propose a complementary view that relies on the wealth reallocation process tak- ing place in speculative markets. We assume that there are two classes of investors trading long-lived assets and holding constantly rebalanced port- folios based on their beliefs. Under the assumption that beliefs, and thus portfolios, are sufficiently diversified, both investors survive in the long-run and, due to waves of strong mispricing, the resulting equilibrium returns exhibit long-term reversal. If moreover asset dividends are positively corre- lated, investors' successful trades become positive correlated thus generating short-term momentum. A market sentiment emerges in that investors' rel- ative wealth dynamics is such that the aggregate investor reacts to news as behavioral models suggest. In addition, our model implies two testable hypotheses of which we offer empirical evidence: dividend autocorrelation is positively related to momentum and negatively related to reversal whereas diversity of beliefs is positively correlated to both momentum and reversal.

Wealth-driven Asymptotic Survival in a Financial Market with Demand Shocks, with Jacopo Staccioli
We investigate long-run returns and wealth dynamics in markets where investors are subject to idiosyncratic shocks to their positions. We find that taking into account the average position of a trader is in general not sufficient to characterise the asymptotic dynamics of the economy. Moreover, long-run heterogeneity, i.e. the simultaneous survival of multiple traders with strictly different portfolio rules, is a generic outcome of the market selection. When the latter occurs, the price and wealth dynamics exhibit endogenous fluctuations that are not observed in models with a representative investor

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