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Heterogeneous Beliefs, Speculation, and the Equity Premium

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  • ALEXANDER DAVID

Abstract

Agents with heterogeneous beliefs about fundamental growth do not share risks perfectly but instead speculate with each other on the relative accuracy of their models' predictions. They face the risk that market prices move more in line with the trading models of competing agents than with their own. Less risk-averse agents speculate more aggressively and demand higher risk premiums. My calibrated model generates countercyclical consumption volatility, earnings forecast dispersion, and cross-sectional consumption dispersion. With a risk aversion coefficient less than one, agents' speculation causes half the observed equity premium and lowers the riskless rate by about 1%. Copyright 2008 by The American Finance Association.

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  • Alexander David, 2008. "Heterogeneous Beliefs, Speculation, and the Equity Premium," Journal of Finance, American Finance Association, vol. 63(1), pages 41-83, February.
  • Handle: RePEc:bla:jfinan:v:63:y:2008:i:1:p:41-83
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