Price Drift as an Outcome of Differences in Higher-Order Beliefs
Posted: 8 Sep 2009
Date Written: September 2009
Motivated by the insight of Keynes (1936) on the importance of higher-order beliefs in financial markets, we examine the role of such beliefs in generating drift in asset prices. We show that in a dynamic setting, a higher-order difference of opinions is necessary for heterogeneous beliefs to generate price drift. Such drift does not arise in standard difference of opinion models, since investors' beliefs are assumed to be common knowledge. Our results stand in contrast to those of Allen, Morris, and Shin (2006) and others, as we argue that in rational expectation equilibria, heterogeneous beliefs do not lead to price drift.
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