COWLES FOUNDATION FOR RESEARCH IN
ECONOMICS Box 208281
COWLES FOUNDATION DISCUSSION PAPER NO. 1827 A Theory of Asset Prices Based on Heterogeneous Information Elias Albagli, Christian Hellwig, and Aleh Tsyvinski October 2011 We propose a theory of asset prices that emphasizes heterogeneous
information as the main element determining prices of different securities. Our main
analytical innovation is in formulating a model of noisy information aggregation through
asset prices, which is parsimonious and tractable, yet flexible in the specification of
cash flow risks. We show that the noisy aggregation of heterogeneous investor beliefs
drives a systematic wedge between the impact of fundamentals on an asset price, and the
corresponding impact on cash flow expectations. The key intuition behind the wedge is that
the identity of the marginal trader has to shift for different realization of the
underlying shocks to satisfy the market-clearing condition. This identity shift amplifies
the impact of price on the marginal trader's expectations. We derive tight
characterization for both the conditional and the unconditional expected wedges. Our first
main theorem shows how the sign of the expected wedge (that is, the difference between the
expected price and the dividends) depends on the shape of the dividend payoff function and
on the degree of informational frictions. Our second main theorem provides conditions
under which the variability of prices exceeds the variability for realized dividends. We
conclude with two applications of our theory. First, we highlight how heterogeneous
information can lead to systematic departures from the Modigliani-Miller theorem. Second,
in a dynamic extension of our model we provide conditions under which bubbles arise. |
