Market Power, Survival and Accuracy of Predictions in Financial Markets

This paper aims to show that the market selection hypothesis in finance is not solely driven by the competitiveness of such markets, as was originally claimed by Alchian [1] and Friedman [4]. Within a standard intertemporal General Equilibrium framework, we allow for an agent to have enough influence on financial markets to strategically affect prices of assets traded. We then show that, as in Sandroni [15], the agent’ long-run consumption will vanish if she makes less accurate predictions than the market, and maintain her market power otherwise. We conclude that the Darwinian justification to this market selection is not the only explanation for the eventual domination of agents making the most accurate predictions. Rather, we claim that the origin of market selection, and in turn of the common prior assumption in asset pricing, is associated with the ability to foresee accurately market uncertainty.