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Portfolio Efficiency Under Heterogeneous Beliefs

In: Recent Advances In Financial Engineering 2009

Author

Listed:
  • Xue-Zhong He

    (School of Finance and Economics, University of Technology, Sydney, PO Box 123, Broadway NSW 2007, Australia)

  • Lei Shi

    (School of Finance and Economics, University of Technology, Sydney, PO Box 123, Broadway NSW 2007, Australia)

Abstract

In the standard mean variance (MV) capital asset pricing model (CAPM) with homogeneous beliefs, the optimal portfolios of investors are MV efficient. It is expected that this is no longer true in general when investors have heterogeneous beliefs in the means and variances/covariances of asset returns. This paper extends the standard Black's zero-beta CAPM to incorporate heterogeneous beliefs and verifies that the subjectively optimal portfolios of heterogeneous investors are MV inefficient in general. The paper then demonstrates that the traditional geometric relation of the mean variance frontiers with and without the riskless asset under homogeneous beliefs does not hold in general under heterogeneous beliefs. The paper further examines the impact of biased beliefs among investors on the MV efficiency of their optimal portfolios. The results provide some explanations on the risk premium puzzle, Miller's hypothesis, and under-performance of managed funds.

Suggested Citation

  • Xue-Zhong He & Lei Shi, 2010. "Portfolio Efficiency Under Heterogeneous Beliefs," World Scientific Book Chapters, in: Masaaki Kijima & Chiaki Hara & Keiichi Tanaka & Yukio Muromachi (ed.), Recent Advances In Financial Engineering 2009, chapter 5, pages 127-156, World Scientific Publishing Co. Pte. Ltd..
    • Handle: RePEc:wsi:wschap:9789814304078_0005
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