A Binomial Model of Asset and Option Pricing with Heterogeneous Beliefs

نویسنده

  • Lei Shi
چکیده

This paper provides a theoretical framework for pricing assets in a multiperiod economy with heterogeneous beliefs. The stock price dynamics follow a binomial lattice structure. Agents are allowed to differ in their beliefs of the probability and asset return in each state of nature. By constructing a consensus belief, we examine the impact of heterogeneous beliefs on market equilibrium. Statically, divergence of opinions leads to lower risk premium, greater divergence of opinions regarding future return in the upstate (downstate) leads to lower (higher) expected return for the risky asset and the risk-free rate. Dynamically, we show that the consensus belief is a fair belief to price options since agents’ wealth share process is a martingale under the consensus belief. Furthermore, call option prices exhibit implied volatility skew when the optimistic (pessimistic) agent is also confident (doubtful) about future asset returns. JEL Classification: G12, D84.

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تاریخ انتشار 2009