The efficient markets hypothesis implies that, in the presence of rational investors, bubbles cannot develop. We analyse the trading behaviour of a sophisticated investor, a London goldsmith bank, during the South Sea bubble in 1720. The bank believed the stock to be overvalued, yet found it...

What role do sentiment investors play in the pricing of newly listed stocks? We derive conditions under which we can distinguish between sentiment and rational pricing behaviour and test for the rationality of small investors’ demand for new stock issues using data from pre-issue (or...

Using an equilibrium asset and option pricing model in a production economy under jump diffusion, we show theoretically that the aggregated excess market returns can be predicted by the skewness risk premium, which is constructed to be the difference between the physical and the risk-neutral...

We show that the local bias in U.S. mutual fund portfolios varies significantly over time and is more pronounced at times of heightened market uncertainty, such as during financial crises. Similarly, the local bias is less pronounced in periods when market sentiment is strong. These results do...

The study analyses the characteristics of professional exchange rate forecasts for the €/US$ rate. The results indicate that the quality of forecasts produced by professional economists is rather poor and incompatible with the rational expectations hypothesis. This dismal result is according...

We analyze the investment decision of a population of time inconsistent entrepreneurs who overweight current payoffs relative to future returns. We show that, in order to avoid inefficient procrastination, agents may find it optimal to keep optimistic priors about their chances of success and...

Investors are keenly interested in financial reports of earnings because earnings provide important information for investment decisions. Thus, executives who are monitored by investors and directors face strong incentives to manage earnings. We introduce consideration of...

Rational investors perceive correctly the value of financial information. Investment in information is therefore rewarded with a higher Sharpe ratio. Overconfident investors overstate the quality of their own information, and thus attain a lower Sharpe ratio. We contrast the implications of the...

A reduction in inflation can fuel run-ups in housing prices if people suffer from money illusion. For example, investors who decide whether to rent or buy a house by simply comparing monthly rent and mortgage payments do not take into account that inflation lowers future real mortgage costs. We...

Does inefficiency of financial markets have real consequences? Or does it only result in transfers of wealth from noise traders to arbitrageurs? We study firm business investment to address this question. In our model, benevolent managers of overvalued companies invest in projects with negative...