A Framework for CAPM with Heterogenous Beliefs

Carl Chiarella, Roberto Dieci and Xuezhong (Tony) He ()
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Roberto Dieci: Department of Mathematics for Economics and Social Sciences, University of Bologna

No 254, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: We introduce heterogeneous beliefs in to the mean-variance framework of the standard CAPM, in contrast to the standard approach which assumes homogeneous beliefs. By assuming that agents form optimal portfolios based upon their heterogeneous beliefs about conditional means and covariances of the risky asset returns, we set up a framework for the CAPM that incorporates the heterogeneous beliefs when the market is in equilibrium. In this framework we first construct a consensus belief (with respect to the means and covariances of the risky asset returns) to represent the aggregate market belief when the market is in equilibrium. We then extend the analysis to a repeated one-period set-up and establish a framework for a dynamic CAPM using a market fraction model in which agents are grouped according to their beliefs. The exact relation between heterogeneous beliefs, the market equilibrium returns and the ex-ante beta-coeffcients is obtained. CAPM and Heterogeneous beliefs.

Pages: 17 pages
Date: 2009-08-01
New Economics Papers: this item is included in nep-cba and nep-fmk
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Citations: View citations in EconPapers (19)

Published as: Chiarella, C., Dieci, R. and He, X., 2009, "A Framework for CAPM with Heterogenous Beliefs", In: Gian Italo Bischi, Carl Chiarella, Laura Gardini (eds), Nonlinear Dynamics in Economics, Finance and Social Sciences: Essays in Honour of John Barkley Rosser Jr, 353-369.

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