Working Paper: CEPR ID: DP4256
Authors: Suleyman Basak
Abstract: This article studies the dynamic behaviour of security prices in the presence of investors? heterogeneous beliefs. We provide a tractable continuous-time pure-exchange model and highlight the mechanism through which investors? differences of opinion enter into security prices. In the determination of equilibrium, we employ a representative investor with stochastic weights and solve for all economic quantities in closed form, including the perceived market prices of risk and interest rate. The basic analysis is generalized to incorporate multiple sources of risk, disagreement about non-fundamentals, and multiple investors. Other applications involving multiple goods and nominal asset pricing within monetary economies are discussed.
Keywords: Asset pricing; Equilibrium; Heterogeneous beliefs; Market price of risk
JEL Codes: C60; D50; D90; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Heterogeneous beliefs among investors (D80) | differentiated pricing of risk in the market (G19) |
| Optimistic beliefs (D84) | taking on more risk by investors (G24) |
| differentiated pricing of risk in the market (G19) | equilibrium interest rate (E43) |
| Disagreement between investors regarding aggregate growth rate (O40) | risk transfer from pessimistic investors to optimistic investors (G41) |
| Differences in beliefs (Z12) | precautionary savings motives related to perceived risks (D14) |