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Evolution of heterogeneous beliefs and asset overvaluation

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  • Shapiro, Dmitry
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    Abstract

    I analyze a model in which different agents have different non-rational expectations about the future price and cash flows of a risky asset. The beliefs in the society evolve according to a very general class of evolution functions that are monotone; that is if one type has increased its share in the population then all types with higher profit should also have increased their shares. I show that the price of the risky asset converges to the risk-neutral fundamental price even though all agents in the economy are risk-averse. The risky asset thus becomes overvalued as compared to the equilibrium with rational expectations. The overvaluation is a result of the evolution of beliefs and does not rely on such asymmetric assumptions as short-sale constraints or optimistic bias.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Mathematical Economics.

    Volume (Year): 45 (2009)
    Issue (Month): 3-4 (March)
    Pages: 277-292

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    Handle: RePEc:eee:mateco:v:45:y:2009:i:3-4:p:277-292

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    Web page: http://www.elsevier.com/locate/jmateco

    Related research

    Keywords: Heterogeneous expectations Evolutionary dynamics Overvaluation Selection mechanisms;

    References

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