Introduction

Surveys of the participants in organized securities markets indicate that traders hold widely different beliefs about the future course of economic activity. Expectations not only differ, but they evidently respond significantly to unexpected movements in such variables as real economic growth and the weekly changes in the money stock [see Cornell (1983) for a review of some of this literature]. Furthermore, French and Roll (1984) have found that the variance of stock prices is greater over periods when the stock market is open than when it is closed. Together, these observations suggest that disparate beliefs and the sharing of information through the trading process may be important ingredients in modeling asset-price determination. The purpose of this paper is to explore the implications of disparate expectations for the time-series properties of asset prices in the context of a simple model with competitive traders facing serially correlated shocks.

While the models examined are partial equilibrium in nature, this exploration is motivated in part by the apparent inconsistency of representative agent, dynamic equilibrium models with the behavior of asset prices. The variances and autocorrelation functions of asset returns seem to be inconsistent with the implications of both linear expectations models [see, e.g., Shiller (1979, 1981), Singleton (1980, 1985), Scott (1985)] and the nonlinear models studied by Hansen and Singleton (1982), Ferson (1983), Dunn and Singleton (1985), and Eichenbaum and Hansen (1985), among others.