Disagreement, Information Quality and Asset Prices

Abstract

We solve analytically a pure exchange general equilibrium model with a continuum of agents that agree to disagree on how they interpret information. Disagreement fluctuates with information quality and the disagreement model is estimated using data on professional forecasts. We find that fluctuations in information quality generate about half the stock price volatility in the data, help explain the equity premium, and explain empirical relations between the forecast dispersion and asset prices. Constant information quality cannot account for the variation in forecast dispersion and in this case, disagreement has almost no effect on the stock return volatility.

Keywords: Asset Prices, Heterogeneous Expectations, Information Quality, Habit-Formation Preferences

JEL Classification: G10, G12