Asset Pricing Under Heterogeneous Information

In an asset market where agents have heterogeneous information, asset prices not only depend their expectations of the true fundamentals but also depend on their expectations of the expectations of others. Iterations of such expectations lead to the so-called “infinite regress” problem, which makes the analysis of asset pricing under heterogenous information challenging. In this paper, we solve the infinite-regress problem in a simple economic setting under a fairly general information structure. This allows us to examine how different forms of information heterogeneity impacts the behavior of asset prices, their return dynamics, trading volume as well as agents’ welfare. We find that in general current prices exhibit long-range dependence on past shocks. Moreover, we show that information heterogeneity tends to lower the level of asset prices, increase price volatility and return variability, and reduce trading volume. It also tends to decrease agents’ welfare, including those with superior information. ∗Qiu is from MIT Sloan School of Management and Wang is from MIT Sloan School of Management, CAFR and NBER.