Competing Theories of Financial Anomalies

We compare two competing theories of financial anomalies: "behavioral" theories built on investor irrationality, and "rational structural uncertainty" theories built on incomplete information about the structure of the economic environment. We find that although the theories relax opposite assumptions of the rational expectations ideal, their mathematical and predictive similarities make them difficult to distinguish. Even if irrationality generates financial anomalies, their disappearance still may hinge on rational learning - that is, on the ability of rational arbitrageurs and their investors to reject competing rational explanations for observed price patterns.

Duke Scholars

Author Alon Brav Fuqua School of Business