Open AccessSpeculation and Financial Wealth Distribution Under Belief Heterogeneity
Author(s) -
Cao Dan
Publication year - 2018
Publication title -
the economic journal
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 4.683
H-Index - 160
eISSN - 1468-0297
pISSN - 0013-0133
DOI - 10.1111/ecoj.12519
Subject(s) - speculation , economics , financial market , collateral , volatility (finance) , margin (machine learning) , incomplete markets , asset (computer security) , monetary economics , distribution (mathematics) , financial economics , microeconomics , finance , mathematical analysis , computer security , mathematics , machine learning , computer science
Under limited commitment that prevents agents from pledging their future non‐financial wealth, agents with incorrect beliefs always survive by holding on to their non‐financial wealth. Friedman's ([Friedman, M., 1953]) market selection hypothesis suggests that their financial wealth trends towards zero in the long run. However, I present a dynamic general equilibrium model with incomplete markets due to collateral constraints and show that the hypothesis depends on the degree of market incompleteness. When markets are more incomplete, over‐optimistic agents not only survive but also prosper by speculation. Stricter margin requirements protect the wealth of the optimists and thereby increase asset price volatility.