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A theory of asset prices based on heterogeneous information

Listed author(s):
  • Christian Hellwig

    (Toulouse School of Economics)

  • Aleh Tsyvinski

    (Yale University)

  • Elias Albagli

    (University of Southern California)

We propose a theory of asset prices that emphasizes heterogeneous information as the main element determining prices of different securities. With only minimal restrictions on security payoffs and trader preferences, noisy aggregation of heterogeneous information drives a systematic wedge between the impact of fundamentals on an asset price, and the corresponding impact on cash flow expectations. From an ex ante perspective, this information aggregation wedge leads to a systematic gap between an asset's expected price and its expected dividend, whose sign and magnitude depend on the asymmetry between upside and downside payoff risks, and on the importance of information heterogeneity. Moreover, when information frictions are sufficiently severe, the model is consistent with arbitrarily high levels of excess price variability as well as low return predictability. Importantly, these results do not rely on traders' risk aversion and thus offer an alternative theory of expected asset returns and price volatility. As applications of our theory, we first highlight how heterogeneous information leads to systematic departures from the Modigliani-Miller theorem and provide a new theory of debt versus equity. Second, in a dynamic extension we provide conditions under which price bubbles are sustainable.

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File URL: https://economicdynamics.org/meetpapers/2012/paper_394.pdf
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Paper provided by Society for Economic Dynamics in its series 2012 Meeting Papers with number 394.

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Date of creation: 2012
Handle: RePEc:red:sed012:394
Contact details of provider: Postal:
Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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  1. Kathy Yuan, 2005. "Asymmetric Price Movements and Borrowing Constraints: A Rational Expectations Equilibrium Model of Crises, Contagion, and Confusion," Journal of Finance, American Finance Association, vol. 60(1), pages 379-411, 02.
  2. Hong, Harrison & Sraer, David, 2013. "Quiet bubbles," Journal of Financial Economics, Elsevier, vol. 110(3), pages 596-606.
  3. Terrance Odean, 1998. "Volume, Volatility, Price and Profit When All Traders Are Above Average," Finance 9803001, EconWPA.
  4. Albagli, Elias & Hellwig, Christian & Tsyvinski, Aleh, 2011. "Information Aggregation, Investment, and Managerial Incentives," CEPR Discussion Papers 8539, C.E.P.R. Discussion Papers.
  5. Masahiro Watanabe, 2008. "Price Volatility and Investor Behavior in an Overlapping Generations Model with Information Asymmetry," Journal of Finance, American Finance Association, vol. 63(1), pages 229-272, 02.
  6. Laura L. Veldkamp, 2011. "Information Choice in Macroeconomics and Finance," Economics Books, Princeton University Press, edition 1, number 9621, June.
  7. Brunnermeier, Markus K., 2001. "Asset Pricing under Asymmetric Information: Bubbles, Crashes, Technical Analysis, and Herding," OUP Catalogue, Oxford University Press, number 9780198296980.
  8. Xavier Vives, 2007. "Information and Learning in Markets," Levine's Bibliography 122247000000001520, UCLA Department of Economics.
  9. Aleh Tsyvinski & Arijit Mukherji & Christian Hellwig, 2006. "Self-Fulfilling Currency Crises: The Role of Interest Rates," American Economic Review, American Economic Association, vol. 96(5), pages 1769-1787, December.
  10. Harrison Hong & Jeremy C. Stein, 2007. "Disagreement and the Stock Market," Journal of Economic Perspectives, American Economic Association, vol. 21(2), pages 109-128, Spring.
  11. T. Clifton Green & Byoung-Hyoun Hwang, 2012. "Initial Public Offerings as Lotteries: Skewness Preference and First-Day Returns," Management Science, INFORMS, vol. 58(2), pages 432-444, February.
  12. Terrance Odean, 1998. "Volume, Volatility, Price, and Profit When All Traders Are Above Average," Journal of Finance, American Finance Association, vol. 53(6), pages 1887-1934, December.
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