Trading and Asset Prices
64 Pages Posted: 3 Sep 2016 Last revised: 21 Aug 2017
Date Written: April 12, 2017
A model is presented with counter-cyclical belief heterogeneity and habit-formation preferences. Belief heterogeneity stems from disagreement in the interpretation of common signals. The model accounts for the positive relation between the magnitude of returns and trading volume, the asymmetric relation between returns and volume, the equity premium and the stock return volatility. If agents are able to create leverage without borrowing, using instead a levered security, the model also accounts for the positive relation between returns and volume. Further, the endogenous belief heterogeneity is negatively correlated with the price-dividend ratio and predicts interest rates; new empirical evidence supports both predictions.
Keywords: Trading Volume, Asset Prices, Heterogeneous Beliefs, External Habit-Formation Preferences.
JEL Classification: G10, G12.
Suggested Citation: Suggested Citation