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.
Authors
- Filippo Massari (ORCID: https://orcid.org/0000-0001-9376-2220)
Institutions
- University of Bologna (IT)
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
Funders
- Università di Bologna