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Differences of Opinion, Endogenous Liquidity, and Asset Prices

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  • Emilio Osambela

Abstract

This paper studies how investors' differences of opinion affect liquidity and asset prices. In our economy, excessively optimistic investors are subject to an endogenous funding constraint that prevents default due to ex-ante-limited commitment. When the funding constraint binds, optimists use their savings to increase their consumption share, deterring default. This allows them to place speculative trades, increasing market liquidity. Their losses on these trades make them prone to default, leading to a renewed binding of the funding constraint. This feedback between funding illiquidity, disagreement, and market liquidity is consistent with several empirical features of liquidity and financial asset prices.

Suggested Citation

  • Emilio Osambela, 2015. "Differences of Opinion, Endogenous Liquidity, and Asset Prices," The Review of Financial Studies, Society for Financial Studies, vol. 28(7), pages 1914-1959.
    • Handle: RePEc:oup:rfinst:v:28:y:2015:i:7:p:1914-1959.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhv001
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    Cited by:

    1. Tiziano De Angelis & Peter Tankov & Olivier David Zerbib, 2022. "Climate Impact Investing," Carlo Alberto Notebooks 676 JEL Classification: G, Collegio Carlo Alberto.
    2. Han, Yufeng & Hu, Ou & Huang, Zhaodan, 2023. "A tale of idiosyncratic volatility and illiquidity shocks: Their correlation and effects on stock returns," International Review of Financial Analysis, Elsevier, vol. 86(C).
    3. Adem Atmaz & Suleyman Basak, 2018. "Belief Dispersion in the Stock Market," Journal of Finance, American Finance Association, vol. 73(3), pages 1225-1279, June.
    4. Broer, Tobias & Kero, Afroditi, 2021. "Collateralization and asset price bubbles when investors disagree about risk," Journal of Banking & Finance, Elsevier, vol. 128(C).
    5. Driouchi, Tarik & So, Raymond H.Y. & Trigeorgis, Lenos, 2020. "Investor ambiguity, systemic banking risk and economic activity: The case of too-big-to-fail," Journal of Corporate Finance, Elsevier, vol. 62(C).
    6. Daniel Andrei & Bruce Carlin & Michael Hasler, 2019. "Asset Pricing with Disagreement and Uncertainty About the Length of Business Cycles," Management Science, INFORMS, vol. 67(6), pages 2900-2923, June.
    7. Dan Li & Geng Li, 2021. "Whose Disagreement Matters? Household Belief Dispersion and Stock Trading Volume [Belief dispersion in the stock market]," Review of Finance, European Finance Association, vol. 25(6), pages 1859-1900.
    8. Dan Bernhardt & Tingjun Liu & Robert Marquez, 2018. "Targeting Target Shareholders," Management Science, INFORMS, vol. 64(4), pages 1489-1509, April.
    9. Chabakauri, Georgy & Han, Brandon Yueyang, 2020. "Collateral constraints and asset prices," Journal of Financial Economics, Elsevier, vol. 138(3), pages 754-776.
    10. Baker, Steven D. & Hollifield, Burton & Osambela, Emilio, 2016. "Disagreement, speculation, and aggregate investment," Journal of Financial Economics, Elsevier, vol. 119(1), pages 210-225.
    11. Park, Sunjin, 2022. "Heterogeneous beliefs in macroeconomic growth prospects and the carry risk premium," Journal of Banking & Finance, Elsevier, vol. 136(C).
    12. Hirota, Shinichi, 2023. "Money supply, opinion dispersion, and stock prices," Journal of Economic Behavior & Organization, Elsevier, vol. 212(C), pages 1286-1310.
    13. Chiu, Junmao & Chung, Huimin, 2019. "Legal institutions and fragile financial markets," Journal of International Money and Finance, Elsevier, vol. 93(C), pages 277-298.
    14. Olivier David Zerbib, 2022. "A Sustainable Capital Asset Pricing Model (S-CAPM): Evidence from Environmental Integration and Sin Stock Exclusion [Asset pricing with liquidity risk]," Review of Finance, European Finance Association, vol. 26(6), pages 1345-1388.

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