Speculation and Financial Wealth Distribution Under Belief Heterogeneity

24 Pages Posted: 17 Sep 2018

See all articles by Dan Cao

Dan Cao

Georgetown University - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: September 2018

Abstract

Under limited commitment that prevents agents from pledging their future non‐financial wealth, agents with incorrect beliefs always survive by holding on to their non‐financial wealth. Friedman's ([Friedman, M., 1953]) market selection hypothesis suggests that their financial wealth trends towards zero in the long run. However, I present a dynamic general equilibrium model with incomplete markets due to collateral constraints and show that the hypothesis depends on the degree of market incompleteness. When markets are more incomplete, over‐optimistic agents not only survive but also prosper by speculation. Stricter margin requirements protect the wealth of the optimists and thereby increase asset price volatility.

Suggested Citation

Cao, Dan, Speculation and Financial Wealth Distribution Under Belief Heterogeneity (September 2018). The Economic Journal, Vol. 128, Issue 614, pp. 2258-2281, 2018, Available at SSRN: https://ssrn.com/abstract=3246037 or http://dx.doi.org/10.1111/ecoj.12519

Dan Cao (Contact Author)

Georgetown University - Department of Economics ( email )

Washington, DC 20057
United States

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