Are stock markets really like beauty contests? Empirical evidence of higher order belief's impact on asset prices

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Are stock markets really like beauty contests? Empirical evidence of higher order belief's impact on asset prices

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Pierre Monnin

Abstract

The goal of this paper is to assess, for the first time, the empirical impact of "Keynes’ beauty contest", or "higher order beliefs", on asset price volatility. The paper shows that heterogeneous expectations induce higher order beliefs and that heterogeneous expectation asset pricing models theoretically generate more volatility than rational expectation models. The paper also explains how, with some assumptions on the distribution of public and private information, a model with higher order beliefs can be empirically estimated. The model is then applied to annual data of the American stock market. The results show that a model with higher order beliefs generates a level of volatility in line with the price volatility observed on the market.

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Paper provided by Institute for Empirical Research in Economics - IEW in its series IEW - Working Papers with number iewwp202.

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Handle: RePEc:zur:iewwpx:202

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Find related papers by JEL classification:
D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies

This paper has been announced in the following NEP Reports:

NEP-ACC-2004-09-30 (Accounting & Auditing)
NEP-ALL-2004-09-30 (All new papers)
NEP-FIN-2004-09-30 (Finance)

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