Asset Pricing Under Keeping Up with the Joneses and Heterogeneous Beliefs

28 Pages Posted: 2 Apr 2012

See all articles by Xuezhong He

Xuezhong He

University of Technology Sydney (UTS) - Finance Discipline Group, Business School; Financial Research Network (FIRN)

Lei Shi

Macquarie University; Financial Research Network (FIRN)

Min Zheng

China Institute for Actuarial Science, Central University of Finance and Economics, China

Date Written: March 27, 2012

Abstract

When agents agree to disagree about the expected growth rate of the aggregate endowment process, we study the asset price dynamics under “Keeping up with the Joneses” (KUJ) meaning that each agent maximizes the expected life-time CRRA utility of his relative consumption to the other agent in the economy. By solving the optimal consumption policies analytically, we obtain the market equilibrium under heterogeneous beliefs. We provide conditions for agents’ long-run survival and show that the market price of risk, risk-free rate, price-dividend ratio in market equilibrium are the consumption share weighted averages of these variables under each agent’s belief. We also show the cyclical behaviour of Sharpe ratio, risk-free rate, price and dividend ratio and stock volatility. Through Monte Carlo simulations, we find that, when the less risk averse agent is relatively optimistic, allowing a small amount of disagreement between agents can explain many market characterizes including excess volatility, a high equity premium and a low risk-free rate identified in financial markets.

Keywords: Keeping up with the Joneses, heterogeneous beliefs, market selection, cyclical behaviour, price-dividend ratio, equity premium, risk-free rate

JEL Classification: G12, D84

Suggested Citation

He, Xue-Zhong 'Tony' and Shi, Lei and Zheng, Min, Asset Pricing Under Keeping Up with the Joneses and Heterogeneous Beliefs (March 27, 2012). Asian Finance Association (AsFA) 2013 Conference. Available at SSRN: https://ssrn.com/abstract=2030003 or http://dx.doi.org/10.2139/ssrn.2030003

Xue-Zhong 'Tony' He

University of Technology Sydney (UTS) - Finance Discipline Group, Business School ( email )

Haymarket
Sydney, NSW 2007
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Lei Shi (Contact Author)

Macquarie University ( email )

New South Wales 2109
Australia
+612 98508478 (Phone)

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Min Zheng

China Institute for Actuarial Science, Central University of Finance and Economics, China ( email )

39 South College Road
Haidian District
Beijing, Beijing 100081
China

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