Evolution of Heterogeneous Beliefs and Asset Overvaluation

29 Pages Posted: 1 Sep 2008

See all articles by Dmitry Shapiro

Dmitry Shapiro

Department of Economics, Seoul National University

Date Written: August 15, 2008

Abstract

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

Shapiro, Dmitry, Evolution of Heterogeneous Beliefs and Asset Overvaluation (August 15, 2008). Available at SSRN: https://ssrn.com/abstract=1260850 or http://dx.doi.org/10.2139/ssrn.1260850

Dmitry Shapiro (Contact Author)

Department of Economics, Seoul National University ( email )

San 56-1, Silim-dong, Kwanak-ku
Seoul 151-742

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