Risk Premiums, Liquidities, and Bubbles under Heterogeneous Beliefs
48 Pages Posted: 17 Aug 2016 Last revised: 17 Nov 2016
Date Written: August 4, 2016
We develop a model in which investors have heterogeneous beliefs about both the mean and the risk of future signals and the final stock payoff. As investors who perceive the lowest risk vary across different periods, the overall perception of the market risk is reduced in an economy with dynamic trading, always reducing risk premium and increasing market liquidity. Bubbles can arise without the short-sales constraint. We show that the more frequently investors trade in the future, the more liquid the market today, which provides potential explanations for a number of empirical findings.
Keywords: Heterogeneous beliefs; Risk premiums; Liquidities; Bubbles
JEL Classification: G10; G12; G14
Suggested Citation: Suggested Citation