Heterogeneous Learning in Capital Markets
17 Pages Posted: 16 Jun 2020 Last revised: 3 Nov 2020
Date Written: November 2, 2020
The only plausible explanation for why capital markets trade so much so often is that they are pervaded by disagreement, aka heterogeneous beliefs. Heterogeneity fades away when risks are stable, as observed history eventually reveals what they are. However, in real-life capital markets, no past stability can ever be guaranteed going forward, and even current risks are too complex for any single trader to grasp. Once we allow for doubts, rational learning can easily fan disagreements, with some traders dismissing surprises as meaningless outliers and others seeing new trends. This can motivate substantial trading even if agents are purely rational.
Keywords: capital markets, trading, heterogeneity, disaster risks, doubt, learning, rationality
JEL Classification: G12, G14, G41
Suggested Citation: Suggested Citation