Hostname: page-component-586b7cd67f-rdxmf Total loading time: 0 Render date: 2024-11-24T23:30:43.990Z Has data issue: false hasContentIssue false
  • English
  • Français

Equilibrium Factor Pricing with Heterogeneous Beliefs

Published online by Cambridge University Press:  06 April 2009

Puneet Handa  and
Scott C. Linn
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper develops an equilibrium factor pricing theory when investors have heterogeneous beliefs about asset payoffs generated by the Ross linear factor model. Investors receive private information about the unknown parameters of the payoff process. They use this private information and equilibrium prices to predict asset payoffs. The paper develops a closed form price function for a noisy rational expectations equilibrium and relates it to the general solution. Even though we allow for a large number of investors, diversity of beliefs and parameter uncertainty both persist in equilibrium. We show that investors' beliefs about expected payoffs are approximately linear in the asset's betas, thus establishing the APT. As investors prefer to hold high information assets in equilibrium, the relative weight of these assets in the APT pricing bound is higher. The reverse is true for low information assets.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 26 , Issue 1 , March 1991 , pp. 11 - 22
Copyright
Copyright © School of Business Administration, University of Washington 1991

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Admati, A. R “A Noisy Rational Expectations Equilibrium for Multi-Asset Securities Markets.” Econometrica, 53 (05 1985), 629–657.CrossRefGoogle Scholar
Anderson, T. W. An Introduction to Multivariate Statistical Analysis. New York: Wiley (1984).Google Scholar
Barry, C, and Brown, S. J.. “Differential Information and Security Market Equilibrium.” Journal of Financial and Quantitative Analysis, 20 (12 1985), 407–422.CrossRefGoogle Scholar
Coles, J. L., and Lowenstein, U.. “Equilibrium Pricing and Portfolio Composition in the Presence of Uncertain Parameters and Estimation Risk.” Journal of Financial Economics, 22 (12 1988), 279–303.CrossRefGoogle Scholar
Connor, G. “A Unified Beta Pricing Theory.” Journal of Economic Theory, 34(10 1984), 13–31.CrossRefGoogle Scholar
Diamond, D. W, and Verrecchia, R. E.. “Information Aggregation in a Noisy Rational Expectations Economy.” Journal of Financial Economics, 9 (09 1981), 221–235.CrossRefGoogle Scholar
Dybvig, P. “An Explicit Bound on Individual Asset's Deviations from APT Pricing in a Finite Economy.” Journal of Financial Economics, 12 (12 1983), 483–496.CrossRefGoogle Scholar
Grinblatt, M, and Titman, S.. “Factor Pricing in a Finite Economy.” Journal of Financial Economics, 12 (12 1983), 497–507.CrossRefGoogle Scholar
Grossman, S. J, and Stiglitz, J. E.. “On the Impossibility of Informationally Efficient Markets.” American Economic Review, 70 (06 1980), 393–408.Google Scholar
Handa, P, and Linn, S. C.. “Intertemporal Arbitrage Pricing with Incomplete Information.” Working Paper, New York Univ. (1989).Google Scholar
Hellwig, M. F. “On the Aggregation of Information in Competitive Markets.” Journal of Economic Theory, 22 (05 1980), 477–498.CrossRefGoogle Scholar
Huberman, G. “A Simple Approach to Arbitrage Pricing Theory.” Journal of Economic Theory, 28 (10 1982), 183–191.CrossRefGoogle Scholar
Ingersoll, J. E Jr, “Some Results in the Theory of Arbitrage Pricing.” Journal of Finance, 39 (09 1984), 1021–1039.CrossRefGoogle Scholar
Klein, R. W, and Bawa, V. S.. “The Effect of Estimation Risk on Optimal Portfolio Choice.” Journal of Financial Economics, 3 (06 1976), 215–231.CrossRefGoogle Scholar
Lintner, J. “The Aggregation of Investors' Diverse Judgements and Preferences in Purely Competitive Securities Markets.” Journal of Financial and Quantitative Analyis, 4 (12 1969), 347–400.CrossRefGoogle Scholar
Merton, R. “A Simple Model of Capital Market Equilibrium with Incomplete Information.” Journal of Finance, 42 (07 1987), 483–510.CrossRefGoogle Scholar
Raiffa, H, and Schlaifer, R.. Applied Statistical Decision Theory. Boston: Harvard Univ. (1961).Google Scholar
Ross, S. “The Arbitrage Theory of Capital Asset Pricing.” Journal of Economic Theory, 13 (12 1976), 341–360.CrossRefGoogle Scholar
Savage, L. J. The Foundations of Statistics. New York: Wiley (1954).Google Scholar
Stambaugh, R. F. “Arbitrage Pricing with Information.” Journal of Financial Economics, 12 (11 1983), 357–369.CrossRefGoogle Scholar
Verrecchia, R. “Information Acquisition in a Noisy Rational Expectations Economy.” Econometrica, 50 (11 1982), 1415–1430.CrossRefGoogle Scholar
Von Neumann, J, and Morgenstern, O.. Theory of Games and Economic Behavior. Princeton: Univ. Press (1944).Google Scholar
White, H. Asymptotic Theory for Econometricians. New York: Academic Press (1984).Google Scholar
Williams, J. T. “Capital Asset Prices with Heterogeneous Beliefs.” Journal of Financial Economics, 5 (11 1977), 219–239.CrossRefGoogle Scholar
Zellner, A, and Chetty, V.. “Prediction and Decision Problems in Regression Models from a Bayesian Point of View.” Journal of the American Statistical Association, 60 (06 1965), 608–616.CrossRefGoogle Scholar