Paris-Princeton Lectures on Mathematical Finance 2003

Volume 1847 of the series Lecture Notes in Mathematics pp 217-250


Heterogeneous Beliefs, Speculation and Trading in Financial Markets

  • José ScheinkmanAffiliated withBendheim Center for Finance, Princeton University Email author 
  • , Wei XiongAffiliated withBendheim Center for Finance, Princeton University

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We survey recent developments in finance that analyze how heterogeneous beliefs among investors generate speculation and trading. We describe the joint effects of heterogeneous beliefs and short-sales constraints on asset prices, using both static and dynamic models, discuss the no-trade theorem in the rational expectations framework, and present investor overconfidence as a potential source of heterogeneous beliefs. We review recent results of Scheinkman and Xiong (2003) modeling the resale option that is embedded in share prices in the presence of short-sale constraints and heterogeneous beliefs, highlighting the implied correlation between stock prices and trading volume. Finally, we discuss the survival of investors with incorrect beliefs.

Mathematics Subject Classification (2000):

92B24 91B28 91B44 91B70 60H30 93E20