Evolution of Heterogeneous Beliefs and Asset Overvaluation
29 Pages Posted: 1 Sep 2008
Date Written: August 15, 2008
I analyze a model in which different agents have different non-rational expectations about the future price and cash flows of a risky asset. The beliefs in the society evolve according to a very general class of evolution functions that are monotone; that is if one type has increased its share in the population then all types with higher profit should also have increased their shares. I show that the price of the risky asset converges to the risk-neutral fundamental price even though all agents in the economy are risk-averse. The risky asset thus becomes overvalued as compared to the equilibrium with rational expectations. The overvaluation is a result of the evolution of beliefs and does not rely on such asymmetric assumptions as short-sale constraints or optimistic bias.
Keywords: heterogeneous expectations, evolutionary dynamics, overvaluation, selection mechanisms
JEL Classification: G12, D83, D84
Suggested Citation: Suggested Citation