Abstract This paper analyzes how an investor who is convinced that he can “beat the market” should behave when the equilibrium price process is endogenous. The investor's optimal portfolio is shown to consist of three components: (1) a tangency portfolio, (2) a hedge portfolio against changes in the market's valuation of securities, and (3) a hedging position against changes in the divergence between the investor's and the market's beliefs. The sign and magnitude of this third component will depend on investor preferences and on the divergence in the investor's and the market's quality of information. A numerical example illustrates that the effect of heterogeneous beliefs on optimal portfolio allocations can be significant. JEL classification codes: G11, G14.

[Implied risk aversion estimates reported in the literature are strongly U-shaped. This article explores different potential explanations for these "smile" patterns: (i) preference aggregation, both with and without stochastic volatility and jumps in returns, (ii) misestimation of investors' beliefs caused by stochastic volatility, jumps, or a Peso problem, and (iii) heterogeneous beliefs. The results reveal that preference aggregation and misestima of investors' beliefs caused by stochastic volatility and jumps are unlikely to be the explanation for the smile. Although a Peso problem can account for the smile, the required probability of a market crash is unrealistically large. Heterogeneous beliefs cause sizable distortions in implied risk aversion, but the degree of heterogeneity required to explain the smile is implausibly large.]

Implied risk aversion estimates reported in the literature are strongly U-shaped. This article explores different potential explanations for these “smile” patterns: (i) preference aggregation, both with and without stochastic volatility and jumps in returns, (ii) misestimation of investors’ beliefs caused by stochastic volatility, jumps, or a Peso problem, and (iii) heterogeneous beliefs. The results reveal that preference aggregation and misestimation of investors’ beliefs caused by stochastic volatility and jumps are unlikely to be the explanation for the smile. Although a Peso problem can account for the smile, the required probability of a market crash is unrealistically large. Heterogeneous beliefs cause sizable distortions in implied risk aversion, but the degree of heterogeneity required to explain the smile is implausibly large.

When information is costly, a seller may wish to prevent prospective buyers from acquiring information, for the cost of information acquisition ultimately is borne by the seller. A seller can achieve the desired prevention through posted-price selling, by offering prospective buyers a discount. No such prevention is possible in the case of an auction. We establish the result that the seller prefers posted-price selling when the cost of information acquisition is high and auctions when it is low. We view corporate bonds as an instance of the former case, and government bonds as an instance of the latter.

Abstract Donald Trump’s 2016 election and his nomination of climate skeptic Scott Pruitt to head the Environmental Protection Agency drastically downshifted expectations about U.S. policy toward climate change. Joseph Biden’s 2020 election shifted them dramatically upward. We study firms’ stock-price movements in reaction to these changes. As expected, the 2016 election boosted carbon-intensive firms. Surprisingly, firms with climate-responsible strategies also gained, especially those firms held by long-run investors. Such investors appear to have bet on a “boomerang” in climate policy. Harbingers of a boomerang appeared during Trump’s term. The 2020 election marked its arrival. (JEL G14, G38, G41)

Donald Trump's surprise election shifted expectations: corporate taxes would be lower and trade policies more restrictive. Relative stock prices responded appropriately. High-tax firms and those with large deferred tax liabilities (DTLs) gained; those with significant deferred tax assets from net operating loss carryforwards (NOL DTAs) lost. Domestically focused companies fared better than internationally oriented firms. A price contribution analysis shows that easily assessed consequences (DTLs, NOL DTAs, tax rates) were priced faster than more complex issues (net DTLs, foreign exposure). In sum, the analysis demonstrates that expectations about tax rates greatly impact firm values.