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A Theory of Asset Prices Based on Heterogeneous Information

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  • Elias Albagli
  • Christian Hellwig
  • Aleh Tsyvinski

Abstract

We propose a theory of asset prices that emphasizes heterogeneous information as the main element determining prices of different securities. With only minimal restrictions on security payoffs and trader preferences, noisy aggregation of heterogeneous information drives a systematic wedge between the impact of fundamentals on an asset price, and the corresponding impact on cash flow expectations. From an ex ante perspective, this information aggregation wedge leads to a systematic gap between an asset's expected price and its expected dividend, whose sign and magnitude depend on the asymmetry between upside and downside payoff risks, and on the importance of information heterogeneity. Moreover, when information frictions are sufficiently severe, the model is consistent with arbitrarily high levels of excess price variability as well as low return predictability. Importantly, these results do not rely on traders' risk aversion and thus offer an alternative theory of expected asset returns and price volatility. As applications of our theory, we first highlight how heterogeneous information leads to systematic departures from the Modigliani-Miller theorem and provide a new theory of debt versus equity. Second, in a dynamic extension we provide conditions under which price bubbles are sustainable.

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Paper provided by David K. Levine in its series Levine's Working Paper Archive with number 786969000000000347.

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Date of creation: 09 Jan 2012
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Handle: RePEc:cla:levarc:786969000000000347

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  1. John H. Cochrane, 1992. "Explaining the Variance of Price Dividend Ratios," NBER Working Papers 3157, National Bureau of Economic Research, Inc.
  2. Diamond, Douglas W. & Verrecchia, Robert E., 1981. "Information aggregation in a noisy rational expectations economy," Journal of Financial Economics, Elsevier, Elsevier, vol. 9(3), pages 221-235, September.
  3. Hellwig, Martin F., 1980. "On the aggregation of information in competitive markets," Journal of Economic Theory, Elsevier, Elsevier, vol. 22(3), pages 477-498, June.
  4. Masahiro Watanabe, 2008. "Price Volatility and Investor Behavior in an Overlapping Generations Model with Information Asymmetry," Journal of Finance, American Finance Association, American Finance Association, vol. 63(1), pages 229-272, 02.
  5. Allen F. & Morris S. & Postlewaite A., 1993. "Finite Bubbles with Short Sale Constraints and Asymmetric Information," Journal of Economic Theory, Elsevier, Elsevier, vol. 61(2), pages 206-229, December.
  6. Christian Hellwig & Arijit Mukherji & Aleh Tsyvinski, 2005. "Self-Fulfilling Currency Crises: The Role of Interest Rates," NBER Working Papers 11191, National Bureau of Economic Research, Inc.
  7. Elias Albagli & Christian Hellwig & Aleh Tsyvinski, 2011. "Information Aggregation, Investment, and Managerial Incentives," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 1816, Cowles Foundation for Research in Economics, Yale University.
  8. Hong, Harrison & Stein, Jeremy, 2007. "Disagreement and the Stock Market," Scholarly Articles 2894690, Harvard University Department of Economics.
  9. Hong, Harrison & Sraer, David, 2013. "Quiet bubbles," Journal of Financial Economics, Elsevier, Elsevier, vol. 110(3), pages 596-606.
  10. West, Kenneth D, 1988. "Dividend Innovations and Stock Price Volatility," Econometrica, Econometric Society, Econometric Society, vol. 56(1), pages 37-61, January.
  11. Spiegel, Matthew, 1998. "Stock Price Volatility in a Multiple Security Overlapping Generations Model," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 11(2), pages 419-47.
  12. Brunnermeier, Markus K., 2001. "Asset Pricing under Asymmetric Information: Bubbles, Crashes, Technical Analysis, and Herding," OUP Catalogue, Oxford University Press, Oxford University Press, number 9780198296980, October.
  13. LeRoy, Stephen F & Porter, Richard D, 1981. "The Present-Value Relation: Tests Based on Implied Variance Bounds," Econometrica, Econometric Society, Econometric Society, vol. 49(3), pages 555-74, May.
  14. Harrison, J Michael & Kreps, David M, 1978. "Speculative Investor Behavior in a Stock Market with Heterogeneous Expectations," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 92(2), pages 323-36, May.
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Cited by:
  1. Gadi Barlevy, 2008. "A leverage-based model of speculative bubbles," Working Paper Series, Federal Reserve Bank of Chicago WP-08-01, Federal Reserve Bank of Chicago.
  2. Ken Kasa & Todd Walker & Charles Whiteman, 2012. "Heterogenous Beliefs and Tests of Present Value Models," Discussion Papers dp12-06, Department of Economics, Simon Fraser University.

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