Survival in Speculative Markets

In this paper, I consider an exchange economy with complete markets where agents have heterogeneous beliefs and, possibly, preferences, and investigate the Market Selection Hypothesis that speculation rewards the agent with the most accurate beliefs. First, on the methodological level, I derive the relative consumption dynamics as a function of agents' effective discount factors, related to consumption decisions across time, and agents' effective beliefs, related to consumption decisions across states. Sufficient conditions for agents' survival, either in isolation or in a group, depend on the relative size of effective discount factors and on the relative accuracy of effective beliefs. Then, I show that in economies where agents maximize an Epstein-Zin utility the Market Selection Hypothesis fails: there exist parametrizations where the agent with correct beliefs vanishes and parametrizations where beliefs heterogeneity persists in the long run. Results are robust to local changes of beliefs, risk preferences, and the aggregate endowment process. These failures are shown not to occur when agents' Epstein-Zin utility has a subjective expected utility representation due to an interdependence of effective discount factors and effective beliefs