Asset Pricing with Heterogeneous Beliefs and Illiquidity

37 Pages Posted: 4 Jun 2019 Last revised: 26 Mar 2020

See all articles by Johannes Muhle-Karbe

Johannes Muhle-Karbe

Imperial College London - Department of Mathematics

Marcel Nutz

Columbia University

Xiaowei Tan

Columbia University - Department of Mathematics

Date Written: March 25, 2020

Abstract

This paper studies the equilibrium price of an asset that is traded in continuous time between N agents who have heterogeneous beliefs about the state process underlying the asset's payoff. We propose a tractable model where agents maximize expected returns under quadratic costs on inventories and trading rates. The unique equilibrium price is characterized by a weakly coupled system of linear parabolic equations which shows that holding and liquidity costs play dual roles. We derive the leading-order asymptotics for small transaction and holding costs which give further insight into the equilibrium and the consequences of illiquidity.

Keywords: Equilibrium, Liquidity, Heterogeneous Beliefs

JEL Classification: C68, D52, G11, G12

Suggested Citation

Muhle-Karbe, Johannes and Nutz, Marcel and Tan, Xiaowei, Asset Pricing with Heterogeneous Beliefs and Illiquidity (March 25, 2020). Available at SSRN: https://ssrn.com/abstract=3388212 or http://dx.doi.org/10.2139/ssrn.3388212

Johannes Muhle-Karbe (Contact Author)

Imperial College London - Department of Mathematics ( email )

South Kensington Campus
Imperial College
LONDON, SW7 1NE
United Kingdom

HOME PAGE: http://www.ma.imperial.ac.uk/~jmuhleka/

Marcel Nutz

Columbia University ( email )

Xiaowei Tan

Columbia University - Department of Mathematics ( email )

United States

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