Equilibrium Asset Pricing Under Heterogeneous Information

Equilibrium Asset Pricing Under Heterogeneous Information
Author: Bruno Biais
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Total Pages: 36
Release: 2004
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We analyze theoretically and empirically the implications of heterogeneous information for equilibrium asset pricing and portfolio choice. Our theoretical framework, directly inspired by Admati (1985), implies that with partial information aggregation, portfolio separation fails, buy-and-hold strategies are not optimal, and investors should structure their portfolios using the information contained in prices in order to cope with winner's curse problems. We implement empirically such a price-contingent portfolio allocation strategy and show that it outperforms economically and statistically the passive/indexing buy-and-hold strategy. We thus demonstrate that prices reveal information, in contrast with the homogeneous information CAPM, but only partially, consistent with a Noisy Rational Expectations Equilibrium. The success of our pricecontingent strategy does not proxy for the success of trading strategies based purely on historical performance, such as momentum investment.

Asset Pricing in a Production Economy with Heterogeneous Investors

Asset Pricing in a Production Economy with Heterogeneous Investors
Author: Jin E. Zhang
Publisher:
Total Pages: 36
Release: 2006
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This paper is a theoretical examination of the stochastic behavior of equilibrium asset prices in an economy consisting of a production process controlled by a state variable representing the state of technology. The investors with different degrees of risk aversion and time preferences trade and lend among themselves in order to maximize their individual utilities of life time consumption. The allocation of wealth fluctuates randomly among them and acts as a state variable against which each investor wants to hedge. This hedging motive complicates the investor's portfolio choice and the equilibrium in the production economy. A general method of constructing equilibrium asset prices is developed and the wealth effect in the general equilibrium is discussed.The equilibrium market prices of risks and risk-free rate in a production economy with one representative investor has been presented by Cox, Ingersoll and Ross (1985). Considerable progress has been made by Dumas (1989) and Vasicek (2005) on the case of heterogeneous investors, however a complete description of the general equilibrium in the production economy with heterogeneous investors is yet to be developed. That is the focus of this paper.This paper establishes an economic model for the equilibrium asset prices by solving the joint optimization problem with proper market clearing conditions. The equilibrium conditions of the two party dynamic game are written as a set of two highly entangled nonlinear partial differential equations. The result can be extended to handle the case of multiple heterogeneous investors.

Incomplete Information, Heterogeneity, and Asset Pricing

Incomplete Information, Heterogeneity, and Asset Pricing
Author: Tony Berrada
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Total Pages:
Release: 2010
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We consider a pure exchange economy where the drift of aggregate consumption is unobservable. Agents with heterogeneous beliefs and preferences act competitively on financial and goods markets. We discuss how equilibrium market prices of risk differ across agents, and in particular we discuss the properties of the market price of risk under the physical (objective) probability measure. We propose a number of specifications of risk aversions and beliefs where the market price of risk is much higher, and the riskless rate of return lower, than in the equivalent full information economy (homogeneous and heterogeneous preferences) and thus can provide an(other) answer to the equity premium and risk-free rate puzzles. We also derive a representation of the equilibrium volatility and numerically assess the role of heterogeneity in beliefs. We show that a high level of stock volatility can be obtained with a low level of aggregate consumption volatility when beliefs are heterogeneous. Finally, we discuss how incomplete information may explain the apparent predictability in stock returns and show that in-sample predictability cannot be exploited by the agents, as it is in fact a result of their learning processes.

A Theory of Asset Pricing Based on Heterogeneous Information

A Theory of Asset Pricing Based on Heterogeneous Information
Author: Elias Albagli
Publisher:
Total Pages: 42
Release: 2011
Genre: Assets (Accounting)
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We propose a theory of asset prices that emphasizes heterogeneous information as the main element determining prices of different securities. Our main analytical innovation is in formulating a model of noisy information aggregation through asset prices, which is parsimonious and tractable, yet flexible in the specification of cash flow risks. We show that the noisy aggregation of heterogeneous investor beliefs drives a systematic wedge between the impact of fundamentals on an asset price, and the corresponding impact on cash flow expectations. The key intuition behind the wedge is that the identity of the marginal trader has to shift for different realization of the underlying shocks to satisfy the market-clearing condition. This identity shift amplifies the impact of price on the marginal trader's expectations. We derive tight characterization for both the conditional and the unconditional expected wedges. Our first main theorem shows how the sign of the expected wedge (that is, the difference between the expected price and the dividends) depends on the shape of the dividend payoff function and on the degree of informational frictions. Our second main theorem provides conditions under which the variability of prices exceeds the variability for realized dividends. We conclude with two applications of our theory. First, we highlight how heterogeneous information can lead to systematic departures from the Modigliani-Miller theorem. Second, in a dynamic extension of our model we provide conditions under which bubbles arise -- National Bureau of Economic Research web site.