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. © 2006 Elsevier B.V. All rights reserved.