Conclusion

We examine the long run survival of nonrational traders in a dynamic, evolutionary model. Specifically, we develop a general population dynamic for a large economy with rational and nonrational traders according to the process of wealth accumulation in asset markets.

The dynamic indicates that the growth rate of wealth accumulation drives the evolutionary process in asset markets. This endogenously determined group wealth accumulation process distinguishes our evolutionary model from the previous models with exogenous imitation processes.

We apply our population dynamic to examine the survival of overconfident traders in a pairwise contest and the survival of noise traders in a playing-the-field contest. We find that neither underconfident nor bearish sentiment can survive.

On the other hand, investors with moderate overconfidence or bullish sentiment can survive in the long run. Furthermore, these moderately aggressive investors may dominate the market if fundamental risk in the market is sufficiently large.

These findings provide interesting new empirical implications for the survivability of active fund management. Overall, our results lend support to the relevance of the psychology of investors with respect to either overconfidence or sentiment for the study of financial markets.

Prof. F. Albert Wang