Speculative Trading with Rational Beliefs and Endogenous Uncertainty

This paper introduces the framework of rational beliefs of Kurz (1994), which makes the assumptions of heterogeneous beliefs of Harrison and Kreps (1978) and Morris (1996) more plausible. Agents hold diverse beliefs that are "rational" in the sense of being compatible with ample observed d...

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Bibliographic Details
Published in:Economic theory 2003-03, Vol.21 (2/3), p.263-292
Main Authors: Wu, Ho-Mou, Guo, Wen-Chung
Format: Article
Language:English
Subjects:
Asset valuation
Correlations
Dividends
Economic expectations
Economic investment
Economic theory
Economic thought
Economic uncertainty
Economics
Equilibrium
Equilibrium prices
Investors
Market equilibrium prices
Market prices
Rationality
Uncertainty
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Summary:This paper introduces the framework of rational beliefs of Kurz (1994), which makes the assumptions of heterogeneous beliefs of Harrison and Kreps (1978) and Morris (1996) more plausible. Agents hold diverse beliefs that are "rational" in the sense of being compatible with ample observed data. In a non-stationary environment the agents only learn about the stationary measure of observed data, but their beliefs can remain non-stationary and diverse. Speculative trading then stems from disagreements among traders. In a Markovian framework of dividends and beliefs, we obtain analytical results to show how the speculative premium depends on the extent of heterogeneity of beliefs. In addition, we demonstrate that there exists a unique Rational Belief Equilibrium (RBE) generically with endogenous uncertainty (as defined by Kurz and Wu, 1996) and that the RBE price is higher than the rational expectation equilibrium price (REE) under some general conditions.
ISSN:0938-2259
1432-0479
DOI:10.1007/s00199-002-0303-x