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Price Drift as an Outcome of Differences in Higher-Order Beliefs

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  • Snehal Banerjee
  • Ron Kaniel
  • Ilan Kremer

Abstract

Motivated by the insight of Keynes (1936) on the importance of higher-order beliefs in financial markets, we examine the role of such beliefs in generating drift in asset prices. We show that in a dynamic setting, a higher-order difference of opinions is necessary for heterogeneous beliefs to generate price drift. Such drift does not arise in standard difference of opinion models, since investors' beliefs are assumed to be common knowledge. Our results stand in contrast to those of Allen, Morris, and Shin (2006) and others, as we argue that in rational expectation equilibria, heterogeneous beliefs do not lead to price drift. The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.

Suggested Citation

  • Snehal Banerjee & Ron Kaniel & Ilan Kremer, 2009. "Price Drift as an Outcome of Differences in Higher-Order Beliefs," Review of Financial Studies, Society for Financial Studies, vol. 22(9), pages 3707-3734, September.
  • Handle: RePEc:oup:rfinst:v:22:y:2009:i:9:p:3707-3734
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    Cited by:

    1. Banerjee, Snehal & Green, Brett, 2015. "Signal or noise? Uncertainty and learning about whether other traders are informed," Journal of Financial Economics, Elsevier, vol. 117(2), pages 398-423.
    2. Liang, Hanchao & Yang, Chunpeng & Cai, Chuangqun, 2017. "Beauty contest, bounded rationality, and sentiment pricing dynamics," Economic Modelling, Elsevier, vol. 60(C), pages 71-80.
    3. Cespa, Giovanni & Vives, Xavier, 2011. "Higher order expectations, illiquidity, and short-term trading," IESE Research Papers D/915, IESE Business School.
    4. Kapetanios, George & Mitchell, James & Shin, Yongcheol, 2014. "A nonlinear panel data model of cross-sectional dependence," Journal of Econometrics, Elsevier, vol. 179(2), pages 134-157.
    5. Hong‐Yi Chen & Pin‐Huang Chou & Chia‐Hsun Hsieh, 2018. "Persistency of the momentum effect," European Financial Management, European Financial Management Association, vol. 24(5), pages 856-892, November.
    6. Andrea Giusto, 2015. "Learning to Agree: A New Perspective on Price Drift," Economics Bulletin, AccessEcon, vol. 35(1), pages 276-282.
    7. Marco Ottaviani & Peter Norman Sørensen, 2015. "Price Reaction to Information with Heterogeneous Beliefs and Wealth Effects: Underreaction, Momentum, and Reversal," American Economic Review, American Economic Association, vol. 105(1), pages 1-34, January.
    8. Albuquerque, Rui & Miao, Jianjun, 2014. "Advance information and asset prices," Journal of Economic Theory, Elsevier, vol. 149(C), pages 236-275.
    9. Au, Pak Hung, 2016. "Price reaction and disagreement over public signal," Journal of Economic Behavior & Organization, Elsevier, vol. 130(C), pages 81-106.
    10. Lubos Pastor & Pietro Veronesi, 2009. "Learning in Financial Markets," Annual Review of Financial Economics, Annual Reviews, vol. 1(1), pages 361-381, November.
    11. Gomes, Francisco J. & Haliassos, Michael & Ramadorai, Tarun, 2020. "Household finance," IMFS Working Paper Series 138, Goethe University Frankfurt, Institute for Monetary and Financial Stability (IMFS).
    12. Giovanni Cespa & Xavier Vives, 2015. "The Beauty Contest and Short-Term Trading," Journal of Finance, American Finance Association, vol. 70(5), pages 2099-2154, October.
    13. Rangvid, Jesper & Schmeling, Maik & Schrimpf, Andreas, 2013. "What do professional forecasters' stock market expectations tell us about herding, information extraction and beauty contests?," Journal of Empirical Finance, Elsevier, vol. 20(C), pages 109-129.
    14. Yang, Chunpeng & Cai, Chuangqun, 2014. "Higher order expectations in sentiment asset pricing model," Economic Modelling, Elsevier, vol. 39(C), pages 95-100.
    15. Winter, Christoph, 2018. "The Impact of Heterogeneous Signals on Stock Price Predictability in a Rational Expectations Model," Working papers 2018/21, Faculty of Business and Economics - University of Basel.
    16. Huang, Shiyang & Liu, Xin & Yin, Chengxi, 2019. "Investor target prices," Journal of Empirical Finance, Elsevier, vol. 54(C), pages 39-57.
    17. Mao, Mike Qinghao & Wei, K.C. John, 2014. "Price and earnings momentum: An explanation using return decomposition," Journal of Empirical Finance, Elsevier, vol. 28(C), pages 332-351.
    18. Egan, Daniel & Merkle, Christoph & Weber, Martin, 2014. "Second-order beliefs and the individual investor," Journal of Economic Behavior & Organization, Elsevier, vol. 107(PB), pages 652-666.
    19. Kenneth J. Singleton, 2014. "Investor Flows and the 2008 Boom/Bust in Oil Prices," Management Science, INFORMS, vol. 60(2), pages 300-318, February.
    20. Giovanni Cespa & Xavier Vives, 2011. "Expectations, Liquidity, and Short-term Trading," CESifo Working Paper Series 3390, CESifo.
    21. Andrei, Daniel & Cujean, Julien, 2017. "Information percolation, momentum and reversal," Journal of Financial Economics, Elsevier, vol. 123(3), pages 617-645.
    22. Negrelli, Sara, 2020. "Bubbles and persuasion with uncertainty over market sentiment," Games and Economic Behavior, Elsevier, vol. 120(C), pages 67-85.
    23. Makarov, Igor & Rytchkov, Oleg, 2012. "Forecasting the forecasts of others: Implications for asset pricing," Journal of Economic Theory, Elsevier, vol. 147(3), pages 941-966.

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