Score contribution per author:
α: calibrated so average coauthorship-adjusted count equals average raw count
Can investors with irrational beliefs be neglected as long as they are rational on average? Do their trades cancel out with no consequences on prices, as implicitly assumed by traditional models? We consider a model with irrational investors, who are rational on average. We obtain waves of pessimism and optimism that lead to countercyclical market prices of risk and procyclical risk-free rates. The variance of the state price density is greatly increased. The long run risk-return relation is modified; in particular, the long run market price of risk might be higher than both the instantaneous and the rational ones. Copyright 2010, Oxford University Press.