Sentiment and speculation in a market with heterogeneous beliefs

Ian Martin and Dimitris Papadimitriou

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: We present a dynamic model featuring risk-averse investors with heterogeneous beliefs. Individual investors have stable beliefs and risk aversion, but agents who were correct in hindsight become relatively wealthy; their beliefs are overrepresented in market sentiment, so "the market" is bullish following good news and bearish following bad news. Extreme states are far more important than in a homogeneous economy. Investors understand that sentiment drives volatility up, and demand high risk premia in compensation. Moderate investors supply liquidity: they trade against market sentiment in the hope of capturing a variance risk premium created by the presence of extremists.

JEL-codes: D81 D83 G11 G12 (search for similar items in EconPapers)
Pages: 60 pages
Date: 2019-05-01
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Citations: View citations in EconPapers (1)

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http://eprints.lse.ac.uk/118936/ Open access version. (application/pdf)

Related works:
Journal Article: Sentiment and Speculation in a Market with Heterogeneous Beliefs (2022)
Working Paper: Sentiment and speculation in a market with heterogeneous beliefs (2022)
Working Paper: Sentiment and Speculation in a Market with Heterogeneous Beliefs (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:118936

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