Risk Premiums, Liquidities, and Bubbles under Heterogeneous Beliefs

48 Pages Posted: 17 Aug 2016 Last revised: 17 Nov 2016

See all articles by Huining Henry Cao

Huining Henry Cao

Cheung Kong Graduate School of Business

Hui Ou-Yang

Cheung Kong Graduate School of Business

Dongyan Ye

Cheung Kong Graduate School of Business

Date Written: August 4, 2016

Abstract

We develop a model in which investors have heterogeneous beliefs about both the mean and the risk of future signals and the final stock payoff. As investors who perceive the lowest risk vary across different periods, the overall perception of the market risk is reduced in an economy with dynamic trading, always reducing risk premium and increasing market liquidity. Bubbles can arise without the short-sales constraint. We show that the more frequently investors trade in the future, the more liquid the market today, which provides potential explanations for a number of empirical findings.

Keywords: Heterogeneous beliefs; Risk premiums; Liquidities; Bubbles

JEL Classification: G10; G12; G14

Suggested Citation

Cao, Huining Henry and Ou-Yang, Hui and Ye, Dongyan, Risk Premiums, Liquidities, and Bubbles under Heterogeneous Beliefs (August 4, 2016). Available at SSRN: https://ssrn.com/abstract=2823089 or http://dx.doi.org/10.2139/ssrn.2823089

Huining Henry Cao

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

Hui Ou-Yang (Contact Author)

Cheung Kong Graduate School of Business ( email )

Hong Kong
China
852-5199-6227 (Phone)

Dongyan Ye

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

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