Value or Growth? Pricing of Idiosyncratic Cash-Flow Risk with Heterogeneous Beliefs

53 Pages Posted: 6 Jul 2015 Last revised: 27 Aug 2015

See all articles by Michael F. Gallmeyer

Michael F. Gallmeyer

University of Virginia (UVA) - McIntire School of Commerce

Hogyu Jhang

Georgia Institute of Technology

Hwagyun Kim

Texas A&M University - Mays Business School

Date Written: July 1, 2015

Abstract

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

Suggested Citation

Gallmeyer, Michael F. and Jhang, Hogyu and Kim, Hwagyun, Value or Growth? Pricing of Idiosyncratic Cash-Flow Risk with Heterogeneous Beliefs (July 1, 2015). Available at SSRN: https://ssrn.com/abstract=2626842 or http://dx.doi.org/10.2139/ssrn.2626842

Michael F. Gallmeyer (Contact Author)

University of Virginia (UVA) - McIntire School of Commerce ( email )

P.O. Box 400173
Charlottesville, VA 22904-4173
United States
434-243-4043 (Phone)
434-924-7074 (Fax)

HOME PAGE: http://www.commerce.virginia.edu/faculty_research/facultydirectory/Pages/Gallmeyer.aspx

Hogyu Jhang

Georgia Institute of Technology ( email )

800 West Peachtree, NW
Office 4219
Atlanta, GA 30338
United States

Hwagyun Kim

Texas A&M University - Mays Business School ( email )

430 Wehner
College Station, TX 77843-4218
United States

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