Incomplete Information, Heterogeneity and Asset Pricing

Les Cahiers du CREF of HEC Montreal Working Paper No. 03-11

71 Pages Posted: 23 Jun 2005

See all articles by Tony Berrada

Tony Berrada

University of Geneva - Geneva Finance Research Institute (GFRI); Swiss Finance Institute

Multiple version iconThere are 2 versions of this paper

Date Written: December 2003

Abstract

We consider a pure exchange economy where the drift of aggregate consumption is unobservable. Agents with heterogeneous beliefs and preferences act competitively on a financial and good markets. We discuss how equilibrium market prices of risk differ across agents, and in particular we discuss the properties of the market price of risk under the physical (objective) probability measure. We provide a number of specification of risk aversions and beliefs where the market price of risk is much higher than in the equivalent full information economy (homogeneous and heterogeneous preferences) and thus could provide an(other) answer to the equity premium puzzle. We also provide a representation of the equilibrium volatility and numerically assess the role of heterogeneity. We show that high level of stock volatility can be obtained with low level of aggregate consumption volatility when beliefs are heterogeneous. Finally we discuss how heterogeneity may explain the apparent predictability in stock return, and show that in-sample predictability can not be exploited by the agents, as it is in fact a result of their learning process.

Keywords: Asset Pricing

JEL Classification: G12

Suggested Citation

Berrada, Tony, Incomplete Information, Heterogeneity and Asset Pricing (December 2003). Les Cahiers du CREF of HEC Montreal Working Paper No. 03-11. Available at SSRN: https://ssrn.com/abstract=746785 or http://dx.doi.org/10.2139/ssrn.746785

Tony Berrada (Contact Author)

University of Geneva - Geneva Finance Research Institute (GFRI) ( email )

40 Boulevard du Pont d'Arve
Geneva 4, 1211
Switzerland

Swiss Finance Institute

c/o University of Geneva
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CH-1211 Geneva 4
Switzerland

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