Differences in Opinion and Risk Premium

Xuezhong (Tony) He () and Lei Shi ()

No 271, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: When people agree to disagree, this paper examines the impact of the disagreement among agents on market equilibrium and equity premium. Within the standard mean variance framework, we consider a market of two risky assets, a riskless asset and two (and then a continuum of) agents who have different preferences and heterogeneous beliefs in the means and variance/covariances of the asset returns. By constructing a consensus belief, we introduce a boundedly rational equilibrium (BRE) to characterize the market equilibrium and derive a CAPM under heterogeneous beliefs. When the differences in opinion are formed as mean-preserving spreads of a benchmark homogeneous belief, we analyz eexplicitly the impact on the market equilibrium and risk premium, showing that the risk tolerance, optimism/pessimism and confidence/doubt can jointly generate high risk premium and low risk-free rate.

Keywords: asset prices; heterogeneous beliefs; boundedly rational equilibrium; zero-beta CAPM; risk premium (search for similar items in EconPapers)
JEL-codes: D84 G12 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2010-02-01
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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