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Non-Equivalent Beliefs and Subjective Equilibrium Bubbles

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  • Martin Larsson
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    Abstract

    This paper develops a dynamic equilibrium model where agents exhibit a strong form of belief heterogeneity: they disagree about zero probability events. It is shown that, somewhat surprisingly, equilibrium exists in this setting, and that the disagreement about nullsets naturally leads to equilibrium asset pricing bubbles. The bubbles are subjective in the sense that they are perceived by some but not necessarily all agents. In contrast to existing models, bubbles arise with no restrictions on trade beyond a standard solvency constraint.

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    File URL: http://arxiv.org/pdf/1306.5082
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    Bibliographic Info

    Paper provided by arXiv.org in its series Papers with number 1306.5082.

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    Date of creation: Jun 2013
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    Handle: RePEc:arx:papers:1306.5082

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    Web page: http://arxiv.org/

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    1. Basak, Suleyman, 2000. "A model of dynamic equilibrium asset pricing with heterogeneous beliefs and extraneous risk," Journal of Economic Dynamics and Control, Elsevier, vol. 24(1), pages 63-95, January.
    2. Basak, Suleyman, 2005. "Asset pricing with heterogeneous beliefs," Journal of Banking & Finance, Elsevier, vol. 29(11), pages 2849-2881, November.
    3. Berrada, Tony & Hugonnier, Julien & Rindisbacher, Marcel, 2007. "Heterogeneous preferences and equilibrium trading volume," Journal of Financial Economics, Elsevier, vol. 83(3), pages 719-750, March.
    4. Napp, Clotilde & Malamud, Semyon & Jouini, Elyès & Cvitanic, Jaksa, 2012. "Financial Markets Equilibrium with Heterogeneous Agents," Economics Papers from University Paris Dauphine 123456789/4724, Paris Dauphine University.
    5. J. Hugonnier & S. Malamud & E. Trubowitz, 2012. "Endogenous Completeness of Diffusion Driven Equilibrium Markets," Econometrica, Econometric Society, vol. 80(3), pages 1249-1270, 05.
    6. Manuel S. Santos & Michael Woodford, 1997. "Rational Asset Pricing Bubbles," Econometrica, Econometric Society, vol. 65(1), pages 19-58, January.
    7. Ely�s Jouini & Clotilde Napp, 2007. "Consensus Consumer and Intertemporal Asset Pricing with Heterogeneous Beliefs," Review of Economic Studies, Oxford University Press, vol. 74(4), pages 1149-1174.
    8. Lior Menzly & Tano Santos & Pietro Veronesi, 2004. "Understanding Predictability," Journal of Political Economy, University of Chicago Press, vol. 112(1), pages 1-47, February.
    9. Hugonnier, Julien, 2012. "Rational asset pricing bubbles and portfolio constraints," Journal of Economic Theory, Elsevier, vol. 147(6), pages 2260-2302.
    10. Mark Loewenstein & Gregory A. Willard, 2006. "The Limits of Investor Behavior," Journal of Finance, American Finance Association, vol. 61(1), pages 231-258, 02.
    11. Jouini, Elyès & Napp, Clotilde, 2007. "Consensus Consumer and Intertemporal Asset Pricing with Heterogeneous Beliefs," Economics Papers from University Paris Dauphine 123456789/78, Paris Dauphine University.
    12. Daniel Fernholz & Ioannis Karatzas, 2010. "On optimal arbitrage," Papers 1010.4987, arXiv.org.
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