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Asset Prices Under Heterogenous Beliefs: Implications for the Equity Premium

  • Andrew B. Abel

An individual investor’s demands for risky capital and riskless bonds depend on the investor’s subjective beliefs about the payoff to risky capital. This paper determines equilibrium asset prices and returns in a capital market in which investors have heterogeneous subjective expectations of the payoff to capital. Increased heterogeneity increases the riskless rate of return and reduces the stock price. Heterogeneity can also dramatically increase the equilibrium equity premium on stocks relative to bonds. Therefore, calculating the equity premium under the assumption of homogeneous beliefs could dramatically understate the equity premium that would prevail under heterogeneity.

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Paper provided by Wharton School Rodney L. White Center for Financial Research in its series Rodney L. White Center for Financial Research Working Papers with number 09-89.

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Handle: RePEc:fth:pennfi:09-89
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