Prices and Portfolio Choices in Financial Markets: Theory, Econometrics, Experiments

Many tests of asset-pricing models address only the pricing predictions, but these pricing predictions rest on portfolio choice predictions that seem obviously wrong. This paper suggests a new approach to asset pricing and portfolio choices based on unobserved heterogeneity. This approach yields the...

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Bibliographic Details
Published in:Econometrica 2007-07, Vol.75 (4), p.993-1038
Main Authors: Bossaerts, Peter, Plott, Charles, Zame, William R.
Format: Article
Language:English
Subjects:
Applications
Asset pricing
Capital Asset Pricing Model
Capital asset pricing models
Capital assets
CAPM
Classical economics
Econometrics
Economic investment
Endowments
Exact sciences and technology
experimental asset markets
Experimental finance
Experiments
Financial engineering
Financial markets
Financial models
Financial portfolios
Inference from stochastic processes
time series analysis
Insurance, economics, finance
Investors
Market portfolios
Market prices
Mathematical finance
Mathematics
Portfolio management
Portfolio selection
Predictions
Probability and statistics
Probability theory and stochastic processes
Risk aversion
Sampling theory, sample surveys
Sciences and techniques of general use
Securities markets
Statistics
Stochastic processes
Studies
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Description
Summary:Many tests of asset-pricing models address only the pricing predictions, but these pricing predictions rest on portfolio choice predictions that seem obviously wrong. This paper suggests a new approach to asset pricing and portfolio choices based on unobserved heterogeneity. This approach yields the standard pricing conclusions of classical models but is consistent with very different portfolio choices. Novel econometric tests link the price and portfolio predictions and take into account the general equilibrium effects of sample-size bias. This paper works through the approach in detail for the case of the classical capital asset pricing model (CAPM), producing a model called CAPM + ε. When these econometric tests are applied to data generated by large-scale laboratory asset markets that reveal both prices and portfolio choices, CAPM + ∊ is not rejected.
ISSN:0012-9682
1468-0262
DOI:10.1111/j.1468-0262.2007.00780.x