Premium
Heterogeneous Beliefs, Speculation, and the Equity Premium
Author(s) -
DAVID ALEXANDER
Publication year - 2008
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.2008.01310.x
Subject(s) - speculation , economics , equity premium puzzle , volatility (finance) , risk premium , econometrics , consumption (sociology) , earnings , equity (law) , risk aversion (psychology) , monetary economics , dispersion (optics) , financial economics , expected utility hypothesis , finance , social science , physics , optics , sociology , political science , law
Agents with heterogeneous beliefs about fundamental growth do not share risks perfectly but instead speculate with each other on the relative accuracy of their models' predictions. They face the risk that market prices move more in line with the trading models of competing agents than with their own. Less risk‐averse agents speculate more aggressively and demand higher risk premiums. My calibrated model generates countercyclical consumption volatility, earnings forecast dispersion, and cross‐sectional consumption dispersion. With a risk aversion coefficient less than one, agents' speculation causes half the observed equity premium and lowers the riskless rate by about 1%.