Does Money Really Talk: Heterogeneous Beliefs, Endogenous Wealth Distribution and Asset Pricing

Project: Research

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Description

Models with heterogeneous investors have the potential to match asset-pricing stylized facts that representative-agent models cannot. Intuitively, investors will value securities differently if they have different beliefs or preferences, and the wealthier one group of investors are, the more power they will have in pricing. The difficulty in modeling models with heterogeneous investors is that one must keep track of individuals' wealth distribution, as the wealth shifts endogenously from one group to another as the natural outcome of trading. It is even more difficult to empirically estimate the model and infer the evolution of the endogenous wealth distribution. This project is the first to estimate a model with heterogeneous beliefs and its time series of the endogenous wealth share to the author's knowledge. The model-implied endogenous wealth share can predict the return correlation between the US treasury bonds and the S&P 500 index. It also predicts the time-varying equity premium. This project then aims to estimate the endogenous wealth shift in financial institutions using survey data. I plan to exploit the panel data of individual forecasts by professional economists in leading financial institutions from the Blue Chip Financial Forecasts. In the estimation, I assume that each financial institution will trade following the forecasts by its economists. Having the estimated panel of endogenous wealth distribution among these financial institutions, I shall perform a similar analysis to see if they collectively predict the correlation between asset returns and the equity premium. We can also directly compare the estimated endogenous wealth distribution with financial institutions' equity distribution as an out of sample test. Since the wealth distribution is an endogenous state variable of the economy, it potentially has a close relation to many finance subjects, including the equity risk premium, bond risk premia, term structure of interest rates, implied volatility, investor sentiment, to name a few. Therefore, this project could lead to more exciting future research.

Detail(s)

Project number9048226
Grant typeECS
StatusNot started
Effective start/end date1/01/22 → …