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Heterogeneous beliefs under recursive preferences

Author

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  • Jaroslav Borovicka

    (University of Chicago)

Abstract

We analyze the impact of heterogeneous beliefs in economies where agents have recursive preferences of the Kreps-Porteus type and differ in their subjective beliefs about the distributions of future quantities. We show that the set of Pareto optimal allocations is given as a solution to a planner's problem with Pareto weights evolving according to an Ito process. In a Markov environment, belief heterogeneity can be incorporated without the need for additional state variables. Using a parsimonious economy, we show that agents with distorted beliefs are not driven out of the market for an empirically relevant range of parameters when preferences are nonseparable across time. Return decomposition reveals nonlinearities in contributions of belief heterogeneity across payoff horizons.

Suggested Citation

  • Jaroslav Borovicka, 2009. "Heterogeneous beliefs under recursive preferences," 2009 Meeting Papers 892, Society for Economic Dynamics.
  • Handle: RePEc:red:sed009:892
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    References listed on IDEAS

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    1. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-969, July.
    2. Isaenko, Sergei, 2008. "The term structure of interest rates in a pure exchange economy where investors have heterogeneous recursive preferences," The Quarterly Review of Economics and Finance, Elsevier, vol. 48(3), pages 457-481, August.
    3. Leonid Kogan & Stephen A. Ross & Jiang Wang & Mark M. Westerfield, 2006. "The Price Impact and Survival of Irrational Traders," Journal of Finance, American Finance Association, vol. 61(1), pages 195-229, February.
    4. Lars Peter Hansen, 2008. "Modeling the Long Run: Valuation in Dynamic Stochastic Economies," NBER Working Papers 14243, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Branger, Nicole & Schlag, Christian & Wu, Lue, 2015. "‘Nobody is perfect’: Asset pricing and long-run survival when heterogeneous investors exhibit different kinds of filtering errors," Journal of Economic Dynamics and Control, Elsevier, vol. 61(C), pages 303-333.
    2. Blume, Lawrence E. & Cogley, Timothy & Easley, David A. & Sargent, Thomas J. & Tsyrennikov, Viktor, 2015. "A Case for Incomplete Markets," Economics Series 313, Institute for Advanced Studies.
    3. Chien, YiLi & Cole, Harold L. & Lustig, Hanno, 2014. "Implications of heterogeneity in preferences, beliefs and asset trading technologies for the macroeconomy," Working Papers 2014-14, Federal Reserve Bank of St. Louis.
    4. Yili Chien & Harold Cole & Hanno Lustig, 2016. "Implications of Heterogeneity in Preferences, Beliefs and Asset Trading Technologies in an Endowment Economy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 20, pages 215-239, April.
    5. Backus, David & Coleman, Chase & Ferriere, Axelle & Lyon, Spencer, 2016. "Pareto weights as wedges in two-country models," Journal of Economic Dynamics and Control, Elsevier, vol. 72(C), pages 98-110.
    6. Kenneth Kasa & Xiaowen Lei, 2017. "Risk, Uncertainty, and the Dynamics of Inequality," Discussion Papers dp17-06, Department of Economics, Simon Fraser University.
    7. Giulio Bottazzi & Pietro Dindo & Daniele Giachini, 2015. "Long-run Heterogeneity in an Exchange Economy with Fixed-Mix Traders," LEM Papers Series 2015/29, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
    8. Riccardo Colacito & Mariano M. Croce, 2012. "International Robust Disagreement," American Economic Review, American Economic Association, vol. 102(3), pages 152-155, May.
    9. Eric Aldrich, 2012. "Trading Volume in General Equilibrium with Complete Markets," 2012 Meeting Papers 36, Society for Economic Dynamics.

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