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A Dynamic Heterogeneous Beliefs CAPM

Author

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  • Carl Chiarella

    (University of Technology Sydney, Australia)

  • Xue-Zhong He

    (University of Technology Sydney, Australia)

  • Roberto Dieci

    (Universita' degli Studi di Bologna, Italy)

  • University of Technology Sydney

Abstract

We reconsider the derivation of the traditional capital asset pricing model (CAPM) in the discrete time setting for a portfolio of one riskless asset and many risky assets. In contrast to the standard setting, it is assumed that agents are heterogeneous in their conditional means and covariances of the risky returns, and that their beliefs about future returns - based on statistical properties of past returns - induce expectations feedback. A Walrasian auctioneer scenario is used for the determination of the market clearing price. In this framework we first construct a consensus belief to represent the aggregate market beliefs about means and variances/covariances of returns, and derive a heterogeneous CAPM which relates aggregate excess return on risky assets with aggregate excess return on the market portfolio via aggregate beta coefficients. We then use this result to establish a dynamic {\em market fraction\/} model in which agents are grouped according to their beliefs. In particular, we focus on three classical heterogeneous agents types - fundamentalists, trend followers and noise traders - and investigate how some of the key agent characteristics affect the time varying behaviour of market returns and beta coefficients

Suggested Citation

  • Carl Chiarella & Xue-Zhong He & Roberto Dieci & University of Technology Sydney, 2006. "A Dynamic Heterogeneous Beliefs CAPM," Computing in Economics and Finance 2006 181, Society for Computational Economics.
    • Handle: RePEc:sce:scecfa:181
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    File URL: http://repec.org/sce2006/up.23422.1140428709.pdf
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    References listed on IDEAS

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    1. Volker Böhm & Carl Chiarella, 2005. "Mean Variance Preferences, Expectations Formation, And The Dynamics Of Random Asset Prices," Mathematical Finance, Wiley Blackwell, vol. 15(1), pages 61-97, January.
    2. Chiarella, Carl & Dieci, Roberto & He, Xue-Zhong, 2007. "Heterogeneous expectations and speculative behavior in a dynamic multi-asset framework," Journal of Economic Behavior & Organization, Elsevier, vol. 62(3), pages 408-427, March.
    3. Carl Chiarella & Roberto Dieci & Laura Gardini, 2005. "The Dynamic Interaction of Speculation and Diversification," Applied Mathematical Finance, Taylor & Francis Journals, vol. 12(1), pages 17-52.
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    Cited by:

    1. Xue-Zhong He & Lei Shi, 2008. "Heterogeneity, Bounded Rationality and Market Dysfunctionality," Research Paper Series 233, Quantitative Finance Research Centre, University of Technology, Sydney.
    2. Xue-Zhong He & Lei Shi, 2009. "Portfolio Analysis and Zero-Beta CAPM with Heterogeneous Beliefs," Research Paper Series 244, Quantitative Finance Research Centre, University of Technology, Sydney.

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