Heterogenous Beliefs and Tests of Present Value Models

Peer reviewed: 
No, item is not peer reviewed.
Scholarly level: 
Faculty/Staff
Date created: 
2012
Keywords: 
Heterogenous beliefs
Volatility
Abstract: 

This paper develops a dynamic asset pricing model with persistent heterogeneous beliefs. The model features competitive traders who receive idiosyncratic signals about an underlying fundamentals process. We adapt Futia’s (1981) frequency domain methods to derive conditions on the fundamentals that guarantee noninvertibility of the mapping between observed market data and the underlying shocks to agents’ information sets. When these conditions are satisfied, agents must ‘forecast the forecasts of others’. The additional dynamics of the heterogeneous beliefs equilibrium can account for observed violations of variance bounds, predictability of excess returns, and rejections of cross-equation restrictions.

Language: 
English
Document type: 
Report
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