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Equity Premium: Interaction of Belief Heterogeneity and Distribution of Wealth?

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Author Info
Filippo Taddei

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Abstract

Introducing heterogeneity of beliefs across different agents builds a link between wealth distribution and the equity premium. We demonstrate that an economy populated only by risk neutral agents may nonetheless display a strictly positive equity premium. We then place our notion of belief heterogeneity within the popular representative agent construct. We show that any level of belief heterogeneity in the multi agent economy can be mapped into some specific degree of risk aversion of the representative agent economy that keeps equilibrium prices constant. A fully dynamic model follows. Finally, we suggest an explanation for the recent behavior of the equity premium: a story of "heterogeneous optimism" versus "homogeneous pessimism" is presented.

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Publisher Info
Paper provided by Collegio Carlo Alberto in its series Carlo Alberto Notebooks with number 67.

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Length: 37 pages
Date of creation: 2007
Date of revision:
Handle: RePEc:cca:wpaper:67

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Related research
Keywords: Belief Heterogeneity; Equity Premium Puzzle; Representative Agent; Risk Aversion; Wealth Distribution.;

Find related papers by JEL classification:
D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
D51 - Microeconomics - - General Equilibrium and Disequilibrium - - - Exchange and Production Economies
D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

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    Other versions:
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    Other versions:
  3. Miller, Edward M, 1977. "Risk, Uncertainty, and Divergence of Opinion," Journal of Finance, American Finance Association, vol. 32(4), pages 1151-68, September. [Downloadable!] (restricted)
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    Other versions:
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  8. Barberis, Nicholas & Thaler, Richard, 2003. "A survey of behavioral finance," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 18, pages 1053-1128 Elsevier. [Downloadable!] (restricted)
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  9. Geanakoplos, John D. & Polemarchakis, Heraklis M., 1982. "We can't disagree forever," Journal of Economic Theory, Elsevier, vol. 28(1), pages 192-200, October. [Downloadable!] (restricted)
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  13. Constantinides, George M, 1982. "Intertemporal Asset Pricing with Heterogeneous Consumers and without Demand Aggregation," Journal of Business, University of Chicago Press, vol. 55(2), pages 253-67, April. [Downloadable!] (restricted)
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  21. Dumas, Bernard, 1989. "Two-Person Dynamic Equilibrium in the Capital Market," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 2(2), pages 157-88. [Downloadable!] (restricted)
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