Financial market equilibria with heterogeneous agents: CAPM and market segmentation

We consider a single-period financial market model with normally distributed returns and the presence of heterogeneous agents. Specifically, some investors are classical Expected Utility Maximizers whereas some others follow Cumulative Prospect Theory. Using well-known functional forms for the preferences, we analytically prove that a Security Market Line Theorem holds. This implies that Capital Asset Pricing Model is a necessary (though not sufficient) requirement in equilibria with positive prices. We correct some erroneous results about existence of equilibria with Cumulative Prospect Theory investors which had appeared in the last few years and we give sufficient conditions for an equilibrium to exist. To circumvent the complexity arising from the interaction of heterogeneous agents, we propose a segmented-market equilibrium model where segmentation is endogenously determined.