Speculation and Financial Wealth Distribution Under Belief Heterogeneity

Economic Journal Forthcoming

64 Pages Posted: 2 Sep 2015 Last revised: 27 Aug 2017

See all articles by Dan Cao

Dan Cao

Georgetown University - Department of Economics

Date Written: November 1, 2013

Abstract

Under limited commitment that prevents agents from pledging their future non-financial wealth, agents with incorrect beliefs always survive by holding on to their non-financial wealth. Friedman (1953)’s market selection hypothesis suggests that their financial wealth trends towards zero in the long run. However, in this paper, we present a dynamic general equilibrium model with incomplete markets due to collateral constraints and show that the hypothesis depends on the degree of market incompleteness. When markets are more incomplete, over-optimistic agents not only survive but also prosper by speculation. But they end up with low long run financial wealth when markets are more complete. In this model, stricter margin requirements protect the wealth of the optimists and thereby increase asset price volatility. The numerical method developed in this paper can be used for many other heterogeneous agent models with recursive utility functions, incomplete markets, portfolio constraints, and in the presence of non-tradable endowments.

Keywords: Heterogeneous Beliefs; Market Selection Hypothesis; Incomplete Markets; Collateral Constraint; Speculation; Asset Pricing; Global Nonlinear Methods

JEL Classification: C62, C68, D52, D53, D84, E44, G12

Suggested Citation

Cao, Dan, Speculation and Financial Wealth Distribution Under Belief Heterogeneity (November 1, 2013). Economic Journal Forthcoming, Available at SSRN: https://ssrn.com/abstract=2654260 or http://dx.doi.org/10.2139/ssrn.2654260

Dan Cao (Contact Author)

Georgetown University - Department of Economics ( email )

Washington, DC 20057
United States

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