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Speculative Equilibrium with Differences in Higher-Order Beliefs

Author

Listed:
  • Jungsuk Han

    (Stockholm School of Economics, SE-113 83 Stockholm, Sweden)

  • Albert S. Kyle

    (Robert H. Smith School of Business, University of Maryland, College Park, Maryland 20742)

Abstract

Modest differences in higher-order beliefs may have large price effects. We generalize a standard rational expectations equilibrium model with different information by allowing differences in higher-order beliefs. Investors have possibly different dogmatic beliefs about the mean, different dogmatic beliefs about other investors’ beliefs, and so on for higher and higher orders of beliefs. Even when every investor’s first-order expectations are unbiased, overvaluation results when investors have inconsistent higher-order beliefs that their own expectations are more optimistic than average. This lack of common knowledge destabilizes prices in an unbounded manner as market liquidity disappears.

Suggested Citation

  • Jungsuk Han & Albert S. Kyle, 2018. "Speculative Equilibrium with Differences in Higher-Order Beliefs," Management Science, INFORMS, vol. 64(9), pages 4317-4332, September.
    • Handle: RePEc:inm:ormnsc:v:64:y:2018:i:9:p:4317-4332
    DOI: 10.1287/mnsc.2017.2759
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    References listed on IDEAS

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    Cited by:

    1. Evan Piermont & Peio Zuazo-Garin, 2021. "Heterogeneously Perceived Incentives in Dynamic Environments: Rationalization, Robustness and Unique Selections," Papers 2105.06772, arXiv.org.

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