Asset Pricing in a Monetary Economy with Heterogeneous Beliefs

35 Pages Posted: 17 Aug 2009

See all articles by Benjamin Croitoru

Benjamin Croitoru

McGill University - Desautels Faculty of Management

Lei Lu

Asper School of Business, University of Manitoba

Date Written: July 2009

Abstract

In this paper, we shed new light on the role of monetary policy in asset pricing by examining the case where investors have heterogeneous expectations about future monetary policy. This case is realistic, because central banks are typically less than perfectly open on their intentions. Accordingly, surveys of economists reveal that they frequently disagree in their expectations. Under heterogeneity in beliefs, investors place bets against each other on the evolution of the money supply, and as a result, the sharing of wealth in the economy evolves stochastically. Employing a continuous-time, general equilibrium model, we establish these fluctuations to be rich in implications, in that they majorly affect the prices of all assets, as well as inflation. In some cases, we are able to derive explicit formulas for important economic quantities. Our model may help explain some empirical puzzles. In particular, we find that the volatility of bond yields and the stock market volatility may be significantly increased by the heterogeneity in beliefs, a conclusion supported by our empirical analysis.

Keywords: asset pricing, continuous-time finance, monetary policy, heterogeneous beliefs, market volatility

JEL Classification: G12, E4, E58

Suggested Citation

Croitoru, Benjamin and Lu, Lei, Asset Pricing in a Monetary Economy with Heterogeneous Beliefs (July 2009). 22nd Australasian Finance and Banking Conference 2009, Available at SSRN: https://ssrn.com/abstract=1455904 or http://dx.doi.org/10.2139/ssrn.1455904

Benjamin Croitoru (Contact Author)

McGill University - Desautels Faculty of Management ( email )

1001 Sherbrooke St. West
Montreal, Quebec H3A1G5 H3A 2M1
Canada
514-398-3237 (Phone)
514-398-3876 (Fax)

Lei Lu

Asper School of Business, University of Manitoba ( email )

181 Freedman Crescent
Winnipeg, Manitoba R3T 5V4
Canada

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