Value or Growth? Pricing of Idiosyncratic Cash-Flow Risk with Heterogeneous Beliefs
53 Pages Posted: 6 Jul 2015 Last revised: 27 Aug 2015
Date Written: July 1, 2015
We study a continuous-time pure exchange economy where idiosyncratic cash flow risks are priced via investors' heterogeneous beliefs. Investors perceive idiosyncratic cash flow risks differently through heterogeneous subjective mean growth rates on a firm's cash flow. This impacts equilibrium quantities. Our model shows that idiosyncratic cash flow shocks priced through belief differences can explain cross-sectional variations in stock returns and cash flows. Quantitative results show that a value premium arises, as value stocks have higher idiosyncratic cash-flow volatilities, lower average cash flows, and higher belief differences, which is empirically supported. A growth premium prevails without belief differences.
Keywords: idiosyncratic cash-flow risk, heterogeneous beliefs, general equilibrium, cross-section of stock returns, habit formation, the value premium
JEL Classification: G00, G02, G10, G11, G12
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