Heterogeneous Beliefs, Asset Prices, and Volatility in a Pure Exchange Economy

Abstract:     
This paper extends the Lucas (1978) model to a setting in which investors have heterogeneous beliefs about the structure of a dividend process. By assuming that all investors have logarithmic preferences and different subjective discount rates, we can obtain a closed-form representation of the stock price. This closed-form solution enables us to analyze the dynamics of the stock price and its volatility. The model can simutaneously generate several well-known empirical facts - excessive volatility, leverage effects, and positive relationships between price and trading volume and between volatility and volume. All of these effects are driven by the different beliefs of investors.

Number of Pages in PDF File: 37

Keywords: Stock Volatility, Trading Volume, Heterogeneous Beliefs, Leverage Effects, Learning

JEL Classification: D53, G11, G12

Accepted Paper Series