We model a dynamic, competitive market, where in every period, risk-neutral traders trade a one-period bond against an infinitely lived asset, with limited short-selling of the long-term asset. Traders lack structural knowledge and use different “incomplete theories,” all of which give statistically correct beliefs about next period's market price of the long-term asset. The more theories there are in the market, the higher is the equilibrium price of the long-term asset. Investors with more complete theories do not necessarily earn higher returns than those with less complete ones, who can earn above the risk-free rate. We provide two necessary conditions for a trader to earn above the risk-free rate.

There is evidence that people do not fully take into account how other people's actions depend on these other people's information. This paper defines and applies a new equilibrium concept in games with private information, cursed equilibrium, which assumes that each player correctly predicts the distribution of other players' actions, but underestimates the degree to which these actions are correlated with other players' information. We apply the concept to common-values auctions, where cursed equilibrium captures the widely observed phenomenon of the winner's curse, and to bilateral trade, where cursedness predicts trade in adverse-selections settings for which conventional analysis predicts no trade. We also apply cursed equilibrium to voting and signalling models. We test a single-parameter variant of our model that embeds Bayesian Nash equilibrium as a special case and find that parameter values that correspond to cursedness fit a broad range of experimental datasets better than the parameter value that corresponds to Bayesian Nash equilibrium.