American Economic Review Vol. 105 No. 1 2015

Price Reaction to Information with Heterogeneous Beliefs and Wealth Effects: Underreaction, Momentum, and Reversal

Marco Ottaviani¹; Peter Norman Sørensen²

¹ Department of Economics and IGIER, Bocconi University, Via Sarfatti 25, 20136 Milan, Italy) · ² Department of Economics, University of Copenhagen, Øster Farimagsgade 5, Building 26, DK-1353 Copenhagen K, Denmark (e-mail: )

Abstract

This paper analyzes how asset prices in a binary market react to information when traders have heterogeneous prior beliefs. We show that the competitive equilibrium price underreacts to information when there is a bound to the amount of money traders are allowed to invest. Underreaction is more pronounced when prior beliefs are more heterogeneous. Even in the absence of exogenous bounds on the amount that traders can invest, prices underreact to information provided that traders become less risk averse as their wealth increases. In a dynamic setting, underreaction results in initial momentum and then reversal in the long run.

DOI

10.1257/aer.20120881

Volume

105

Issue

1

Pages

01-34

Language

en

Sources

bibtex:phds-export.bib openalex crossref

Cite

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