Dynamic portfolio choice and asset pricing with differential information

This paper presents a multi-asset intertemporal general equilibrium model of portfolio selection and asset pricing with differential information. A method of Sargent (1991) is used to resolve the 'infinite regress' problem in information extraction and to derive a rational expectations equilibrium. The model shows that rational investors trade stocks strategically according to their perceptions about economic states and provides a rationale for investors to hold less than perfectly diversified portfolios. The information distribution among investors has an important effect on stock prices, welfare, and the investment opportunities of investors; The model helps explain a number of interesting financial regularities such as imperfect portfolio diversification and home bias. Published by Elsevier Science B.V.