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A Model of Equity Prices with Heterogeneous Beliefs

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  • Suzuki, Masakazu
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    Abstract

    This paper analyzes the effect of interaction among heterogeneous investors on equity prices. We classify investors into three groups according to their information sets and beliefs: informed investors, trend followers, and contrarians. Then, the equity price is derived through the market clearing condition. Our model explains many anomalous phenomena in the equity markets, including excess volatility, the momentum effect, and the mean-reverting effect. Further, the empirical analysis shows that the difference in returns behavior between small- and large-cap equities in the U.S. market can be explained by differences in the composition of investors.

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    File URL: http://hermes-ir.lib.hit-u.ac.jp/rs/bitstream/10086/19220/1/HJeco0520100410.pdf
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    Bibliographic Info

    Article provided by Hitotsubashi University in its journal Hitotsubashi Journal of Economics.

    Volume (Year): 52 (2011)
    Issue (Month): 1 (June)
    Pages: 41-54

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    Handle: RePEc:hit:hitjec:v:52:y:2011:i:1:p:41-54

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    Related research

    Keywords: Heterogeneous Beliefs; Equity Prices; Excess Volatility; Momentum Effect; Meanreverting Effect;

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    1. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, vol. 71(3), pages 421-36, June.
    2. Andrew W. Lo & A. Craig MacKinlay, 1989. "Stock Market Prices Do Not Follow Random Walks: Evidence From a Simple Specification Test," NBER Working Papers 2168, National Bureau of Economic Research, Inc.
    3. Campbell, John, 2000. "Asset Pricing at the Millennium," Scholarly Articles 3294737, Harvard University Department of Economics.
    4. Wang, Jiang, 1993. "A Model of Intertemporal Asset Prices under Asymmetric Information," Review of Economic Studies, Wiley Blackwell, vol. 60(2), pages 249-82, April.
    5. Harrison Hong & Jeremy C. Stein, 1999. "A Unified Theory of Underreaction, Momentum Trading, and Overreaction in Asset Markets," Journal of Finance, American Finance Association, vol. 54(6), pages 2143-2184, December.
    6. LeRoy, Stephen F, 1973. "Risk Aversion and the Martingale Property of Stock Prices," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 14(2), pages 436-46, June.
    7. Jegadeesh, Narasimhan & Titman, Sheridan, 1993. " Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency," Journal of Finance, American Finance Association, vol. 48(1), pages 65-91, March.
    8. Barberis, Nicholas & Shleifer, Andrei & Vishny, Robert, 1998. "A model of investor sentiment," Journal of Financial Economics, Elsevier, vol. 49(3), pages 307-343, September.
    9. De Bondt, Werner F M & Thaler, Richard, 1985. " Does the Stock Market Overreact?," Journal of Finance, American Finance Association, vol. 40(3), pages 793-805, July.
    10. Narasimhan Jegadeesh, 2001. "Profitability of Momentum Strategies: An Evaluation of Alternative Explanations," Journal of Finance, American Finance Association, vol. 56(2), pages 699-720, 04.
    11. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
    12. Williams, Joseph T., 1977. "Capital asset prices with heterogeneous beliefs," Journal of Financial Economics, Elsevier, vol. 5(2), pages 219-239, November.
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