Aggregation of Heterogeneous Beliefs and Asset Pricing Theory: A Mean-Variance Analysis

Quantitative Finance Research Centre Working Paper No. 186

23 Pages Posted: 17 Mar 2008

See all articles by Carl Chiarella

Carl Chiarella

University of Technology, Sydney - UTS Business School, Finance Discipline Group

Roberto Dieci

Department of Mathematics, University of Bologna

Xuezhong He

University of Technology Sydney (UTS) - Finance Discipline Group, Business School; Financial Research Network (FIRN)

Date Written: October 2006

Abstract

Within the standard mean-variance framework, this paper provides a procedure to aggregate the heterogeneous beliefs in not only risk preferences and expected payoffs but also variances/covariances into a market consensus belief. Consequently, an asset equilibrium price under heterogeneous beliefs is derived. We show that the market aggregate behavior is in principle a weighted average of heterogeneous individual behaviors. The CAPM-like equilibrium price and return relationships under heterogeneous beliefs are obtained. The impact of diversity of heterogeneous beliefs on the market aggregate risk preference, asset volatility, equilibrium price and optimal demands of investors is examined. As a special case, our result provides a simple explanation for the empirical relation between cross-sectional volatility and expected returns.

JEL Classification: G12, D84

Suggested Citation

Chiarella, Carl and Dieci, Roberto and He, Xue-Zhong 'Tony', Aggregation of Heterogeneous Beliefs and Asset Pricing Theory: A Mean-Variance Analysis (October 2006). Quantitative Finance Research Centre Working Paper No. 186, Available at SSRN: https://ssrn.com/abstract=1106065 or http://dx.doi.org/10.2139/ssrn.1106065

Carl Chiarella (Contact Author)

University of Technology, Sydney - UTS Business School, Finance Discipline Group ( email )

PO Box 123
Broadway, NSW 2007
Australia
+61 2 9514 7719 (Phone)
+61 2 9514 7711 (Fax)

HOME PAGE: http://www.business.uts.edu.au/finance/

Roberto Dieci

Department of Mathematics, University of Bologna ( email )

Piazza di Porta San Donato, 5
Bologna, I-40126
Italy

HOME PAGE: http://www.unibo.it/Faculty/default.aspx?UPN=roberto.dieci%40unibo.it

Xue-Zhong 'Tony' He

University of Technology Sydney (UTS) - Finance Discipline Group, Business School ( email )

Haymarket
Sydney, NSW 2007
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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