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Heterogenous Beliefs and Tests of Present Value Models

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Abstract

This paper develops a dynamic asset pricing model with persistent heterogeneous beliefs. The model features competitive traders who receive idiosyncratic signals about an underlying fundamentals process. We adapt Futia’s (1981) frequency domain methods to derive conditions on the fundamentals that guarantee noninvertibility of the mapping between observed market data and the underlying shocks to agents’ information sets. When these conditions are satisfied, agents must ‘forecast the forecasts of others’. The additional dynamics of the heterogeneous beliefs equilibrium can account for observed violations of variance bounds, predictability of excess returns, and rejections of cross-equation restrictions.

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  • Ken Kasa & Todd Walker & Charles Whiteman, 2012. "Heterogenous Beliefs and Tests of Present Value Models," Discussion Papers dp12-06, Department of Economics, Simon Fraser University.
  • Handle: RePEc:sfu:sfudps:dp12-06
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    1. Elias Albagli & Christian Hellwig & Aleh Tsyvinski, 2011. "A Theory of Asset Prices Based on Heterogeneous Information," Cowles Foundation Discussion Papers 1827, Cowles Foundation for Research in Economics, Yale University.
    2. Kristoffer Nimark, 2007. "Dynamic higher order expectations," Economics Working Papers 1118, Department of Economics and Business, Universitat Pompeu Fabra, revised Mar 2011.
    3. Brunnermeier, Markus K., 2001. "Asset Pricing under Asymmetric Information: Bubbles, Crashes, Technical Analysis, and Herding," OUP Catalogue, Oxford University Press, number 9780198296980.
    4. 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.
    5. Campbell, John Y & Shiller, Robert J, 1987. "Cointegration and Tests of Present Value Models," Journal of Political Economy, University of Chicago Press, vol. 95(5), pages 1062-1088, October.
    6. J. Michael Harrison & David M. Kreps, 1978. "Speculative Investor Behavior in a Stock Market with Heterogeneous Expectations," The Quarterly Journal of Economics, Oxford University Press, vol. 92(2), pages 323-336.
    7. Foster, F Douglas & Viswanathan, S, 1996. " Strategic Trading When Agents Forecast the Forecasts of Others," Journal of Finance, American Finance Association, vol. 51(4), pages 1437-1478, September.
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    Cited by:

    1. Alessi, Lucia & Kerssenfischer, Mark, 2016. "The response of asset prices to monetary policy shocks: stronger than thought," Working Paper Series 1967, European Central Bank.
    2. Martin Ellison & Andreas Tischbirek, 2018. "Beauty Contests and the Term Structure," Economics Series Working Papers 846, University of Oxford, Department of Economics.
    3. Djeutem, Edouard & Kasa, Kenneth, 2013. "Robustness and exchange rate volatility," Journal of International Economics, Elsevier, vol. 91(1), pages 27-39.
    4. Tan, Fei & Walker, Todd B., 2015. "Solving generalized multivariate linear rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 60(C), pages 95-111.
    5. George-Marios Angeletos & Zhen Huo, 2018. "Myopia and Anchoring," NBER Working Papers 24545, National Bureau of Economic Research, Inc.
    6. Hamidi Sahneh, Mehdi, 2017. "News, Noise, and Tests of Present Value Models," MPRA Paper 82715, University Library of Munich, Germany.
    7. He, Xue-Zhong & Zheng, Huanhuan, 2016. "Trading heterogeneity under information uncertainty," Journal of Economic Behavior & Organization, Elsevier, vol. 130(C), pages 64-80.
    8. Markku Lanne & Henri Nyberg, 2015. "Nonlinear dynamic interrelationships between real activity and stock returns," CREATES Research Papers 2015-36, Department of Economics and Business Economics, Aarhus University.
    9. Lof Matthijs, 2013. "Noncausality and asset pricing," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 17(2), pages 211-220, April.
    10. Athreya, Kartik B., 2014. "Big Ideas in Macroeconomics: A Nontechnical View," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262019736.
    11. repec:eee:eneeco:v:65:y:2017:i:c:p:424-433 is not listed on IDEAS
    12. Nyholm, Juho, 2017. "Residual-based diagnostic tests for noninvertible ARMA models," MPRA Paper 81033, University Library of Munich, Germany.

    More about this item

    Keywords

    Heterogenous beliefs; Volatility;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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