The Inefficient Markets Hypothesis: Why Financial Markets Do Not Work Well in the Real World

Roger Farmer, Carine Nourry and Alain Venditti

No 9283, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Existing literature continues to be unable to offer a convincing explanation for the volatility of the stochastic discount factor in real world data. Our work provides such an explanation. We do not rely on frictions, market incompleteness or transactions costs of any kind. Instead, we modify a simple stochastic representative agent model by allowing for birth and death and by allowing for heterogeneity in agents' discount factors. We show that these two minor and realistic changes to the timeless Arrow-Debreu paradigm are sufficient to invalidate the implication that competitive financial markets efficiently allocate risk. Our work demonstrates that financial markets, by their very nature, cannot be Pareto efficient, except by chance. Although individuals in our model are rational; markets are not.

Keywords: Asset pricing; Efficient markets; Excess volatility (search for similar items in EconPapers)
JEL-codes: E32 E44 G10 G12 G14 (search for similar items in EconPapers)
Date: 2013-01
New Economics Papers: this item is included in nep-fmk and nep-mac
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Citations: View citations in EconPapers (12)

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Related works:
Working Paper: The Inefficient Markets Hypothesis: Why Financial Markets Do Not Work Well in the Real World (2014)
Working Paper: The Inefficient Markets Hypothesis: Why Financial Markets Do Not Work Well in the Real World (2013)
Working Paper: The Inefficient Markets Hypothesis: Why Financial Markets Do Not Work Well in the Real World (2013)
Working Paper: The Inefficient Markets Hypothesis: Why Financial Markets Do Not Work Well in the Real World (2012)
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