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Asset Prices with Heterogeneity in Preferences and Beliefs

Raman Uppal and Harjoat Bhamra

No 1344, 2013 Meeting Papers from Society for Economic Dynamics

Abstract: In this paper, we study asset prices in a dynamic, continuous-time, general-equilibrium endowment economy where agents have “catching up with the Joneses†utility functions and differ with respect to their beliefs (because of differences in priors) and their preference parameters for time discount, risk aversion, and sensitivity to habit. A key contribution of our paper is to demonstrate how one can obtain a closed-form solution to the consumption-sharing rule for agents who have both heterogeneous priors and heterogeneous preferences without restricting the risk aversion of the two agents to special values. We solve in closed form also for the the state price density, the riskless interest rate and market price of risk; the stock price, equity risk premium, and volatility of stock returns; the term structure of interest rates; and the conditions necessary to obtain a stationary equilibrium in which both agents survive in the long run. The methodology we develop is sufficiently general that, as long as markets are complete, it can be applied to models set in discrete or continuous time, to endowment processes that are in the exponential affine jump-diffusion class, and, to settings with arbitrary updating of beliefs.

Date: 2013
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Journal Article: Asset Prices with Heterogeneity in Preferences and Beliefs (2014) Downloads
Working Paper: Asset Prices with Heterogeneity in Preferences and Beliefs (2013) Downloads
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