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A theory of asset prices based on heterogeneous information

  • 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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Paper provided by Society for Economic Dynamics in its series 2012 Meeting Papers with number 394.

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Date of creation: 2012
Date of revision:
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
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  1. Cochrane, John H, 1992. "Explaining the Variance of Price-Dividend Ratios," Review of Financial Studies, Society for Financial Studies, vol. 5(2), pages 243-80.
  2. Harrison, J Michael & Kreps, David M, 1978. "Speculative Investor Behavior in a Stock Market with Heterogeneous Expectations," The Quarterly Journal of Economics, MIT Press, vol. 92(2), pages 323-36, May.
  3. Hong, Harrison & Stein, Jeremy, 2007. "Disagreement and the Stock Market," Scholarly Articles 2894690, Harvard University Department of Economics.
  4. Spiegel, Matthew, 1998. "Stock Price Volatility in a Multiple Security Overlapping Generations Model," Review of Financial Studies, Society for Financial Studies, vol. 11(2), pages 419-47.
  5. Elias Albagli & Christian Hellwig & Aleh Tsyvinski, 2011. "Information Aggregation, Investment, and Managerial Incentives," Levine's Working Paper Archive 786969000000000197, David K. Levine.
  6. Xavier Vives, 2007. "Information and Learning in Markets," Levine's Bibliography 122247000000001520, UCLA Department of Economics.
  7. West, Kenneth D, 1988. "Dividend Innovations and Stock Price Volatility," Econometrica, Econometric Society, vol. 56(1), pages 37-61, January.
  8. Christian Hellwig & Arijit Mukherji & Aleh Tsyvinski, 2005. "Self-Fulfilling Currency Crises: The Role of Interest Rates," NBER Working Papers 11191, National Bureau of Economic Research, Inc.
  9. 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.
  10. LeRoy, Stephen F & Porter, Richard D, 1981. "The Present-Value Relation: Tests Based on Implied Variance Bounds," Econometrica, Econometric Society, vol. 49(3), pages 555-74, May.
  11. Allen F. & Morris S. & Postlewaite A., 1993. "Finite Bubbles with Short Sale Constraints and Asymmetric Information," Journal of Economic Theory, Elsevier, vol. 61(2), pages 206-229, December.
  12. 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.
  13. Diamond, Douglas W. & Verrecchia, Robert E., 1981. "Information aggregation in a noisy rational expectations economy," Journal of Financial Economics, Elsevier, vol. 9(3), pages 221-235, September.
  14. Harrison Hong & David Sraer, 2012. "Quiet Bubbles," NBER Working Papers 18547, National Bureau of Economic Research, Inc.
  15. Brunnermeier, Markus K., 2001. "Asset Pricing under Asymmetric Information: Bubbles, Crashes, Technical Analysis, and Herding," OUP Catalogue, Oxford University Press, number 9780198296980.
  16. Hellwig, Martin F., 1980. "On the aggregation of information in competitive markets," Journal of Economic Theory, Elsevier, vol. 22(3), pages 477-498, June.
  17. 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.
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