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Rev Fin 2002; 15:575-606
© 2002 the Society for Financial Studies

Competing Theories of Financial Anomalies

Alon Brav
Duke University

J.B. Heaton
Bartlit Beck Herman Palenchar & Scott and Duke University

Abstract

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.


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