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Evolution of heterogeneous beliefs and asset overvaluation

  • Shapiro, Dmitry
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    I analyze a model in which different agents have different non-rational expectations about the future price and cash flows of a risky asset. The beliefs in the society evolve according to a very general class of evolution functions that are monotone; that is if one type has increased its share in the population then all types with higher profit should also have increased their shares. I show that the price of the risky asset converges to the risk-neutral fundamental price even though all agents in the economy are risk-averse. The risky asset thus becomes overvalued as compared to the equilibrium with rational expectations. The overvaluation is a result of the evolution of beliefs and does not rely on such asymmetric assumptions as short-sale constraints or optimistic bias.

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    File URL: http://www.sciencedirect.com/science/article/B6VBY-4TYYTCR-1/2/a2a3d8906c8f25cde11f5b8cc0ef36e3
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    Article provided by Elsevier in its journal Journal of Mathematical Economics.

    Volume (Year): 45 (2009)
    Issue (Month): 3-4 (March)
    Pages: 277-292

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    Handle: RePEc:eee:mateco:v:45:y:2009:i:3-4:p:277-292
    Contact details of provider: Web page: http://www.elsevier.com/locate/jmateco

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