Differences of Opinion and the Price Volume Relation

For the first time in the asset pricing literature a direct link is drawn between asset prices and the financial volume of trade within a dynamic general equilibrium model with disagreement. The model exhibits two risk averse agents that hold heterogeneous beliefs about the conditional mean of the only source of macroeconomic risk, the aggregate consumption growth. The differences in opinions is supported by the fact that agents interpret public information differently. The model is able to explain a number of seemingly unrelated asset pricing facts namely the positive correlation between price changes and volume, the contemporaneous relation between volume and return volatility, the excess volatility, the volatility persistence and the negative correlation between price levels and volatility. The inability of existing models of trading to uncover such relations lies first on the simplistic preference assumptions and especially of risk-neutrality. When agents are sufficiently risk-averse prices become decreasing with the level of disagreement and trading is proportional to disagreement. Further, once we recognize that this disagreement is time-varying we are able to give an explanation to all the mentioned pricing and volume empirical evidence. I would like thank Fernando Zapatero, Antonios Sangvinatsos, Chris Jones, Selale Tuzel, Jesus Sierra and Breno Schmidt for their helpful comments and suggestions. I would like to especially thank my advisor Prof. Zapatero for his overall guidance and interesting discussions. :PhD student at the department of Finance and Business economics, Marshall School of Business, University of Southern California, Los Angeles, CA 90089-0804, USA (e-mail: [email protected]) USC FBE FINANCE SEMINAR presented by Costas Xiouros FRIDAY, Dec. 12, 2008 10:30 am – 12:00 pm, Room: JKP-202