Asset Pricing with Heterogeneous Beliefs and Illiquidity
35 Pages Posted: 4 Jun 2019
Date Written: May 14, 2019
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
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