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Asset Prices with Heterogeneity in Preferences and Beliefs

71 Pages Posted: 19 Mar 2009 Last revised: 8 Jan 2015

Harjoat Singh Bhamra

Imperial College Business School

Raman Uppal

EDHEC Business School; Centre for Economic Policy Research (CEPR)

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Date Written: May 28, 2013

Abstract

In this paper, we study asset prices in a dynamic, continuous-time, general-equilibrium endowment economy where agents have “catching up with the Joneses” utility functions and differ with respect to their beliefs (because of differences in priors) and their preference parameters for time discount, risk aversion, and sensitivity to habit. A key contribution of our paper is to demonstrate how one can obtain a closed-form solution to the consumption-sharing rule for agents who have both heterogeneous priors and heterogeneous preferences without restricting the risk aversion of the two agents to special values. We solve in closed form also for the the state-price density, the riskless interest rate and market price of risk; the stock price, equity risk premium, and volatility of stock returns; the term structure of interest rates; and the conditions necessary to obtain a stationary equilibrium in which both agents survive in the long run. The methodology we develop is sufficiently general that, as long as markets are complete, it can be used to obtain the sharing rule and state prices for models set in discrete or continuous time and for arbitrary endowment and belief updating processes.

Keywords: heterogeneity, general equilibrium, stationarity, equity risk premium, volatility

JEL Classification: D51, G12

Suggested Citation

Bhamra, Harjoat Singh and Uppal , Raman, Asset Prices with Heterogeneity in Preferences and Beliefs (May 28, 2013). AFA 2010 Atlanta Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1365032 or http://dx.doi.org/10.2139/ssrn.1365032

Harjoat Singh Bhamra (Contact Author)

Imperial College Business School ( email )

Tanaka Building
Exhibition Rd
London, SW7 2AZ
United Kingdom

HOME PAGE: http://www.harjoatbhamra.com

Raman Uppal

EDHEC Business School ( email )

58 rue du Port
Lille, 59046
France

Centre for Economic Policy Research (CEPR)

90-98 Goswell Road
London, EC1V 7RR
United Kingdom

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