Get access

The Limits of Investor Behavior




    Search for more papers by this author
    • Both authors are at the Smith School of Business, University of Maryland. We thank Kerry Back, Alexandre Baptiste, Shmuel Baruch, Zvi Bodie, Phil Dybvig, Steve Heston, Jon Lewellen, Hong Liu, Jacob Oded, Anna Pavlova, Gordon Phillips, Nagpurnanand Prabhala, Steve Ross, Vish Viswanathan, Elaine Walsh, Mark Westerfield, and seminar participants at Ajou University, Boston University, George Washington University, Massachussetts Institute of Technology, Pohang University, Rutgers, and the University of Maryland for their comments. We also thank Rob Stambaugh and two anonymous referees. Willard thanks the General Research Board at the University of Maryland for its financial support of this paper.


Many models use noise trader risk and corresponding violations of the Law of One Price to explain pricing anomalies, but include a storage technology in perfectly elastic supply or unlimited asset liability. Storage allows aggregate consumption risk to differ from exogenous fundamental risk, but using aggregate consumption as a factor for asset returns can make noise trader risk superfluous. Using (i) limited asset liability and limited storage withdrawals, or (ii) an endogenous locally riskless interest rate eliminates violations of the Law of One Price. Our main results use only budget equations and market clearing, and require virtually no assumptions about behavior.