The dynamics of efficient asset trading with heterogeneous beliefs

Abstract

This paper analyzes the dynamic properties of portfolios that sustain dynamically complete markets equilibria when agents have heterogeneous priors. We argue that the conventional wisdom that belief heterogeneity generates continuous trade and significant fluctuations in individual portfolios may be correct but it needs some qualifications. We consider an infinite horizon stochastic endowment economy populated by many Bayesian agents with heterogeneous priors over the stochastic process of the states of nature. Our approach hinges on studying the portfolios that decentralize Pareto optimal allocations. Since these allocations are typically history dependent, we propose a methodology to provide a complete recursive characterization when agents believe that the process of states of nature is i.i.d. but disagree about the probability of the states. We show that even though heterogeneous priors within that class can indeed generate genuine changes in the portfolios of any dynamically complete markets equilibrium, these changes vanish with probability one if the true process consists of i.i.d. draws from a common distribution and the support of every agent's prior belief contains the true distribution. Finally, we provide examples in which asset trading does not vanish because either (i) no agent learns the true conditional probability of the states or (ii) some agent does not know the true process generating the data is i.i.d.Keywords: heterogeneous beliefs, asset trading, dynamically complete markets. * We thank Rody Manuelli and Juan Dubra for detailed comments. We are also very grateful to one of the referees for very detailed comments that greatly improved the paper and the proof of Proposition 16. All the remaining errors are ours.

Diverse Beliefs, Survival and the Market Price of Risk

“…We put individuals in a setting in which the only information revealed by prices is subjective probabilities of future gs. We do this by assuming that agents have different Beker and Espino (2008) study limiting portfolios and volume in a related economy. 6 The term Ôtrue F Õ has no special status in the theory underlying the Walrasian competitive equilibrium prices and allocations.…”

Implications of Heterogeneity in Preferences, Beliefs and Asset Trading Technologies for the Macroeconomy

“…In a related vein, Cvitanic, Jouini, Malamud, and Napp (2011) derive analytic characterizations of an exchange economy with differing beliefs, risk aversion and time preference, and show that asymptotically prices are determined by the agents how place the most value on consumption in those states. (See also Ross, Westerfield, Wang, and Kogan (2011), Beker and Espino (2011) and Beker and Espino (2013). ) In terms of the role of recursive preferences and the differing affects of risk aversion and the IES on asset pricing and consumption, we find that increasing the IES modestly increases the volatility of a household's consumption but does to change their portfolios.…”

Self-Fulfilling Prophecies, Quasi Non-Ergodicity & Wealth Inequality

“…Previous related work includes Blume and Easley (2006) who study the asymptotic properties of consumption and Sargent (2008, 2009) who study asset prices in an economy with informed and uninformed agents. The closest previous paper to ours is by Beker and Espino (2011) who study a stochastic endowment economy populated by infinitely-lived Bayesian updaters.…”