A Theory of Asset Prices Based on Heterogeneous Information

48 Pages Posted: 15 Mar 2012

See all articles by Elias Albagli

Elias Albagli

University of Southern California - Marshall School of Business; Central Bank of Chile

Aleh Tsyvinski

Yale University - Cowles Foundation

Christian Hellwig

University of Toulouse 1 - Toulouse School of Economics (TSE)

Multiple version iconThere are 3 versions of this paper

Date Written: March 14, 2012

Abstract

We propose a theory of asset prices that emphasizes heterogeneous information as the main element determining prices of different securities. Our main analytical innovation is in formulating a model of noisy information aggregation through asset prices, which is parsimonious and tractable, yet flexible in the specification of cash flow risks. We show that the noisy aggregation of heterogeneous investor beliefs drives a systematic wedge between the impact of fundamentals on an asset price, and the corresponding impact on cash flow expectations. The key intuition behind the wedge is that the identity of the marginal trader purchasing the security has to shift for different realization of the underlying shocks to satisfy the market-clearing condition. This identity shift amplifies the impact of price on the marginal trader's expectations. We derive tight characterization for both the conditional and the unconditional expected wedges. Our first main theorem shows how the sign of the expected wedge (that is, the difference between the expected price and the dividends) depends on the shape of the dividend payoff function and on the degree of informational frictions. Our second main theorem provides conditions under which the variability of prices exceeds the variability of realized dividends. We conclude with two applications of our theory. First, we highlight how heterogeneous information can lead to systematic departures from the Modigliani-Miller theorem. Second, in a dynamic extension of our model we provide conditions under which bubbles arise.

Keywords: Heterogeneous information, limits to arbitrage, information wedge

JEL Classification: E44, G12, G14, G30

Suggested Citation

Albagli, Elias and Tsyvinski, Aleh and Hellwig, Christian, A Theory of Asset Prices Based on Heterogeneous Information (March 14, 2012). AFA 2013 San Diego Meetings Paper. Available at SSRN: https://ssrn.com/abstract=2022530 or http://dx.doi.org/10.2139/ssrn.2022530

Elias Albagli (Contact Author)

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd
Los Angeles, CA 90089
United States
56987096932 (Phone)

HOME PAGE: http://www.marshall.usc.edu/faculty/directory/albagli

Central Bank of Chile ( email )

Publicaciones
Huerfanos 1185
Santiago
Chile

Aleh Tsyvinski

Yale University - Cowles Foundation ( email )

28 Hillhouse Ave
New Haven, CT 06520-8268
United States
203-432-9163 (Phone)

Christian Hellwig

University of Toulouse 1 - Toulouse School of Economics (TSE) ( email )

Place Anatole-France
Toulouse Cedex, F-31042
France

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