Working Paper: CEPR ID: DP15573
Authors: Roger E. A. Farmer; Jean-Philippe Bouchaud
Abstract: We construct a model of an exchange economy in which agents trade assets contingent on an observable signal, the probability ofwhich depends on public opinion. The agents in our model are replaced occasionally and each person updates beliefs in response toobserved outcomes. We show that the distribution of the observed signal is described by a quasi-non-ergodic process and that peoplecontinue to disagree with each other forever. Interestingly, these disagreements generate large wealth inequalities that arise from themultiplicative nature of wealth dynamics which makes successful bold bets highly pro table. People who agree with the market beliefhave a low expected subjective gain from trading. People who disagree may either become spectacularly rich, or spectacularly poor. The flip side is that such wealth inequalities lead to persistent discrepancies between market implied probabilities and true probabilities.
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JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| public opinion (D72) | wealth distribution (D31) |
| disagreements among agents regarding public signal (D82) | wealth inequalities (D31) |
| multiplicative dynamics of wealth accumulation (E21) | wealth inequalities (D31) |
| bold bets by agents who disagree with market beliefs (G40) | extreme wealth outcomes (D31) |
| agents who agree with market beliefs (L85) | lower expected subjective gains from trading (G41) |
| agents with differing beliefs (L85) | substantial wealth fluctuations (E21) |
| wealth distribution (D31) | Pareto tail (D39) |
| market prices (P22) | wealth-weighted average of individual beliefs (G40) |
| market-implied probabilities (G13) | true underlying probabilities (C11) |