Under-reaction: Irrational behavior or robust response to model misspecification?

Abstract I find that under-reaction is a robust response to model misspecification, rewarded by financial markets, rather than an “irrational” attitude that leads to extinction. When a Bayesian agent trades with an under-reacting agent who has access to the same information, there are no paths on which the under-reacting agent loses all his wealth to the Bayesian. Conversely, the Bayesian agent loses all his wealth to the under-reacting agent in misspecified learning settings, provided that a combination of parameters is more accurate than any single parameter in the support, and the under-reaction is sufficiently strong.

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Publication Details

Journal
Economic Theory
Published
2025-08-12
DOI
https://doi.org/10.1007/s00199-025-01677-x
Citations
1
Primary Topic
Financial Markets and Investment Strategies
Type
article
Field-Weighted Citation Impact
2.21

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article

Under-reaction: Irrational behavior or robust response to model misspecification?

Filippo Massari
1 citations
Economic Theory
Financial Markets and Investment Strategies
2.21
article

Under-reaction: Irrational behavior or robust response to model misspecification?

Filippo Massari
article en
1 citations

Abstract

Abstract I find that under-reaction is a robust response to model misspecification, rewarded by financial markets, rather than an “irrational” attitude that leads to extinction. When a Bayesian agent trades with an under-reacting agent who has access to the same information, there are no paths on which the under-reacting agent loses all his wealth to the Bayesian. Conversely, the Bayesian agent loses all his wealth to the under-reacting agent in misspecified learning settings, provided that a combination of parameters is more accurate than any single parameter in the support, and the under-reaction is sufficiently strong.

Economic Theory
University of Bologna (IT)
Università di Bologna
Openalex Percentile: Top 12%
Financial Markets and Investment Strategies
2.21
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