Contributions published at Finance

It has been widely noted in the empirical literature that state-price densities implicit in financial asset prices are not log-normal. This paper shows that this phenomenon can be caused by heterogeneity in investors’ beliefs. It derives the state-price density under heterogeneous beliefs in closed form and demonstrates that heterogeneous beliefs can give rise to multimodal state-price densities. Consequences for the “smile effect” in implied option volatility and for measures of risk aversion inferred from empirical state-price densities are discussed.

One of the striking phenomena in recent stock market history is the continuous rise in stock prices. Classical explanations for this phenomenon have argued that these apparently high valuations are either caused by measurement error in accounting data, or by high expected future growth in dividends. In this paper, it is shown that a high degree of uncertainty about expected growth in dividends can lead to an increase in stock prices. Moreover, dividend growth uncertainty can lead stock prices to over- or underreact to changes in dividends.

This paper analyzes how an investor who is convinced that he can "beat the market" should behave when the equilibrium price process is endogenous. The investor's optimal portfolio is shown to consist of three components: (1) a tangency portfolio, (2) a hedge portfolio against changes in the market's valuation of securities, and (3) a hedging position against changes in the divergence between the investor's and the market's beliefs. The sign and magnitude of this third component will depend on investor preferences and on the divergence in the investor's and the market's quality of information. A numerical example illustrates that the effect of heterogeneous beliefs on optimal portfolio allocations can be significant.