Heterogeneous beliefs, asset prices, and volatility in a pure exchange economy

This paper extends the Lucas [1978. Asset prices in an exchange economy. Econometrica 46, 1429-1445] model to a setting in which investors have heterogeneous beliefs about the structure of a dividend process. By assuming that all investors have logarithmic preferences and different subjective discount rates, we can obtain a closed-form representation of the stock price. This closed-form solution enables us to analyze the dynamics of the stock price and its volatility. The model can simultaneously generate several well-known empirical facts excessive volatility, leverage effects, and positive relationships between price and trading volume and between volatility and volume. All of these effects are driven by the different beliefs of investors. (C) 2006 Elsevier B.V. All rights reserved.