Price Dynamics and Market Selection in Small and Large Economies

Abstract

This paper investigates the hypothesis that markets favor traders with more accurate beliefs. Unlike existing results, notably Sandroni (2000) and Blume-Easley (2006), I propose an approach that (i) is directly informative about equilibrium prices, (ii) provides a condition that is necessary as well as sucient for the wealth-share of a trader to converge to zero, and (iii) can be applied to both small and large economies. My analysis reveals that these two settings are qualitatively dierent. In small economies, irrespective of traders’ risk attitudes, markets select for traders with more accurate beliefs. In large economies, risk attitudes can play a determinant role on the survival of a trader: there are cases in which the wealth-share of a group of traders with rational expectations converges to zero even if no other trader in the economy has correct beliefs.