A Theory of Asset Prices Based on Heterogeneous Information
AbstractWe propose a theory of asset prices that emphasizes heterogeneous information as the main element determining prices of different securities. Our main analytical innovation is in formulating a model of noisy information aggregation through asset prices, which is parsimonious and tractable, yet flexible in the specification of cash flow risks. We show that the noisy aggregation of heterogeneous investor beliefs drives a systematic wedge between the impact of fundamentals on an asset price, and the corresponding impact on cash flow expectations. The key intuition behind the wedge is that the identity of the marginal trader has to shift for different realization of the underlying shocks to satisfy the market-clearing condition. This identity shift amplifies the impact of price on the marginal trader's expectations. We derive tight characterization for both the conditional and the unconditional expected wedges. Our first main theorem shows how the sign of the expected wedge (that is, the difference between the expected price and the dividends) depends on the shape of the dividend payoff function and on the degree of informational frictions. Our second main theorem provides conditions under which the variability of prices exceeds the variability for realized dividends. We conclude with two applications of our theory. First, we highlight how heterogeneous information can lead to systematic departures from the Modigliani-Miller theorem. Second, in a dynamic extension of our model we provide conditions under which bubbles arise.
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Bibliographic InfoPaper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1827.
Length: 43 pages
Date of creation: Oct 2011
Date of revision:
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Other versions of this item:
- Elias Albagli & Christian Hellwig & Aleh Tsyvinski, 2012. "A Theory of Asset Prices Based on Heterogeneous Information," Levine's Working Paper Archive 786969000000000347, David K. Levine.
- Albagli, Elias & Hellwig, Christian & Tsyvinski, Aleh, 2013. "A Theory of Asset Prices based on Heterogeneous Information," CEPR Discussion Papers 9291, C.E.P.R. Discussion Papers.
- Christian Hellwig & Aleh Tsyvinski & Elias Albagli, 2012. "A theory of asset prices based on heterogeneous information," 2012 Meeting Papers 394, Society for Economic Dynamics.
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
- G30 - Financial Economics - - Corporate Finance and Governance - - - General
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-10-22 (All new papers)
- NEP-CBA-2011-10-22 (Central Banking)
- NEP-CIS-2011-10-22 (Confederation of Independent States)
- NEP-UPT-2011-10-22 (Utility Models & Prospect Theory)
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