Price Drift as an Outcome of Differences in Higher Order Beliefs
Kellogg School of Management - Department of Finance
University of Rochester - Simon Business School; CEPR
AFA 2007 Chicago Meetings Paper
Review of Financial Studies, Forthcoming
Motivated by the insight of Keynes (1936) on the importance of higher order beliefs in financial markets, we examine the role of such beliefs in generating drift in asset prices. We show that in a dynamic setting, a higher order difference of opinions is necessary for heterogeneous beliefs to generate price drift. Such drift does not arise in standard difference of opinion models, since investors' beliefs are assumed to be common knowledge. Our results stand in contrast to Allen, Morris and Shin (2006) and others, as we argue that in rational expectation equilibria, heterogeneous beliefs do not lead to price drift.
Number of Pages in PDF File: 25
Keywords: price drift, momentum, rational, difference, opinion
Date posted: March 16, 2006 ; Last revised: November 30, 2009
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