Price Drift as an Outcome of Differences in Higher-Order Beliefs

Snehal Banerjee; Ron Kaniel; Ilan Kremer

doi:10.1093/rfs/hhp014

Price Drift as an Outcome of Differences in Higher-Order Beliefs

Snehal Banerjee^1,2; Ron Kaniel^3,4,5; Ilan Kremer⁶

¹ Kellogg's (Canada) · ² University of California San Diego · ³ Center for Economic and Policy Research · ⁴ Duke University · ⁵ University of Rochester · ⁶ Stanford University

Review of Financial Studies 2009 open access

Motivated by the insight of Keynes (1936) on the importance of higher-order beliefs in financial markets, we examine the role of such beliefs in generating drift in asset prices. We show that in a dynamic setting, a higher-order difference of opinions is necessary for heterogeneous beliefs to generate price drift. Such drift does not arise in standard difference of opinion models, since investors' beliefs are assumed to be common knowledge. Our results stand in contrast to those of Allen, Morris, and Shin (2006) and others, as we argue that in rational expectation equilibria, heterogeneous beliefs do not lead to price drift.

DOI: 10.1093/rfs/hhp014
Volume: 22 (9)
Pages: 3707-3734
Language: en
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