Rational expectations, difference of opinions and asset pricing

Yimin Zhou and Rui Chen

Applied Economics, 2018, vol. 50, issue 31, 3331-3337

Abstract: This article applies the concept of relative overconfidence (the measure of how heavily investors depend on others’ information) to combine the rational expectations equilibrium (REE) and difference of opinions (DO) models. And we discuss the effects of relative overconfidence on asset price efficiency and trading volume. We find that when investors hold assets to maturity, relative overconfidence has no effect on price efficiency and trading volume; however, when investors speculate, relative overconfidence reduces price informativeness and trading volume, because investors will reckon asset prices as more noisy and find it meaningless to speculate on capital gains based on their private information. Our results highlight the role of speculation in differentiating REE and DO models and influencing the effects of overconfidence.

Date: 2018
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DOI: 10.1080/00036846.2017.1420892

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