Dynamic asset pricing model with heterogeneous sentiments

a r t i c l e i n f o The systematic and important role of investor sentiment has been supported by some recent empirical and theoretical literatures. In this paper, we present a dynamic asset pricing model with heterogeneous sentiments and we find that the equilibrium stock price is the wealth-share-weighted average of the stock prices that would prevail in an economy with one sentiment investor only. Moreover, heterogeneous sentiments induce fluctuations in the wealth distribution, which increases stock return volatility and induces mean reversion in stock returns. The model offers a partial explanation for the financial anomaly of mean reversion. Traditional asset pricing theory suggests that economists can safely ignore individual irrational behavior at the aggregate level (Friedman, 1953). But this argument is not adopted by behavioral finance, which argues that the investment strategy may be impacted by investor noise, investor psychology, or investor sentiment. Some noise trader models are proposed to illustrate the influence of noise on the stock price (De long et al., 1990; Yan, 2010). For example, Yan (2010) presented a noise model, where individual biases often cannot be cancelled out by aggregation. The shortcoming of noise models is that the noise information is difficult to be identified and cannot be measured, consequently can't be empirically testified. Yang and Yan (2011) suggested that investor sentiment is easy to be measured by variant methods and the related result is supported by some financial experiments (Statman et al., 2008). Nowadays, the systematic role of investor sentiment has been supported by some empirical and theoretical studies. A number of empirical studies have shown that investor sentiment has a systematic impact on stock return Some static asset pricing models have been developed to support the role of investor sentiment, such as Yang et al. showed that the excess return is negatively related to a high sentiment bigger than a critical point, but positively related to a high sentiment smaller than this point. Yang et al. (2012) presented a sentiment capital asset pricing model, and showed that investor sentiment is a nonlinear systematic factor for asset pricing. Yang and Zhang (2013a) presented a sentiment asset pricing model with consumption, and showed that the stock price has a wealth-weighted average structure and the investor's wealth proportion could amplify the sentiment shock on the asset price. These static asset pricing models have showed the systematic impact of the investor sentiment on …