Prices and portfolio choices in financial markets: Theory, econometrics, experiments

Abstract

Opinions, findings, conclusions and recommendations expressed in this material are those of the authors and do not necessarily reflect the views of any funding agency. Prices and Portfolio Choices in Financial Markets: Theory and Experiment Most tests of asset pricing models address only the pricing predictions — perhaps because the portfolio choice predictions are obviously wrong. But how can pricing theory be right if the portfolio choice theory on which it rests is wrong? This paper suggests an answer: the assumptions about individual preferences that underly common asset-pricing models are wrong, but the deviations between the demands predicted by these models and the true demands have mean zero in the population, and hence wash out in prices. The starting point for this work is a set of experimental markets in which risky and riskless assets are traded. This experimental setting offers an op-portunity to study asset pricing in an environment in which crucial variable