Heterogeneous Beliefs and Learning about the Expected Return in a Market for a Short-Lived Asset

Richard Smith

The Financial Review, 1993, vol. 28, issue 1, 1-24

Abstract: This paper examines the properties of asset prices in an economy in which the true expected return on an asset is unknown and investors have heterogeneous assessments of the expected return. The principal innovation of the analysis is that the formation and evolution of investors's beliefs are modeled in a Bayesian framework. Among other things, this allows one to operationalize the notion on investor confidence. The dispersion of beliefs is, in contrast to the findings of many existing studies, not vacuous for asset prices and, in fact, can have virtually any qualitative effect on asset prices depending on the parameterization. The model has implications for the volatility of asset prices and shows that learning can give rise to some unconventional relationships, such as an inverse relationship between asset prices and risk. Copyright 1993 by MIT Press.

Date: 1993
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