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Optimists, Pessimists, and the Stock Market: The Role of Preferences and Market (In)Completeness

56 Pages Posted: 18 Nov 2013 Last revised: 1 Oct 2015

Nicole Branger

University of Muenster - Finance Center Muenster

Patrick Konermann

BI Norwegian Business School

Christian Schlag

Goethe University Frankfurt - Research Center SAFE

Date Written: September 21, 2015

Abstract

We show that a sizable equity premium is compatible with pronounced risk sharing between an optimistic and a pessimistic Epstein-Zin investor in a long-run risk model featuring jumps in expected consumption growth. Our model generates a positive correlation between return volatility and trading volume, as it is observed in the data. Furthermore, it reproduces the stylized fact of a positive link between disagreement and expected returns, volatilities, and trading volume. We investigate the impact of preferences, fundamental dynamics, and market incompleteness in detail and highlight their respective importance for each of our results.

Keywords: Epstein-Zin utility, heterogeneous beliefs, disagreement, long-run risk, market incompleteness

JEL Classification: D52, D53, G12

Suggested Citation

Branger, Nicole and Konermann, Patrick and Schlag, Christian, Optimists, Pessimists, and the Stock Market: The Role of Preferences and Market (In)Completeness (September 21, 2015). Available at SSRN: https://ssrn.com/abstract=2356502 or http://dx.doi.org/10.2139/ssrn.2356502

Nicole Branger

University of Muenster - Finance Center Muenster ( email )

Universitatsstr. 14-16
Muenster, 48143
Germany
+49 251 83 29779 (Phone)
+49 251 83 22867 (Fax)

HOME PAGE: http://www.wiwi.uni-muenster.de/fcm/fcm/das-finance-center/details.php?weobjectID=162

Patrick Konermann (Contact Author)

BI Norwegian Business School ( email )

Nydalsveien 37
Oslo, 0442
Norway

Christian Schlag

Goethe University Frankfurt - Research Center SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany
+49 69 798 33699 (Phone)
+49 69 798 33901 (Fax)

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