On the Evolutionary Stability of the Sentiment Investor

This chapter investigates whether a behaviourally biased agent is able to persistently maintain a positive consumption share when trading in the market with a Bayesian agent. The question is addressed by recasting a popular model of investor sentiment in a general equilibrium framework. Our evolutionary stability analysis complements standard Behavioural Finance studies, where a biased representative agent is usually considered to explain deviations from rational pricing. In fact, if the biased agent asymptotically disappears from the market, then misvaluation patters generated by its behaviour do not survive in the long term. We find that, despite the existence of generic cases in which the biased agent succumbs, the learning process with behavioural biases displays a good degree of evolutionary stability.