Essays in asset pricing with belief dispersion and learning

Atmaz, Adem (2015) Essays in asset pricing with belief dispersion and learning. Doctoral thesis, University of London: London Business School.

Abstract

This thesis is structured around three main chapters which study investors' belief dispersion and learning in financial markets. In the first chapter of my thesis I study short interest. Short interest is a widely used measure of short selling activity for a stock but its driving factors and dynamics are not well understood theoretically. To study short interest I develop a general equilibrium model in which Bayesian investors differ in their beliefs. I find that short interest depends on and increases in only one quantity, investors' belief disagreement and in particular does not relate to pessimism nor predicts future returns. In the second chapter, I explore the role of incomplete information and learning in the stock market. In this regard, I develop a general equilibrium model in which the representative agent does not fully observe the stochastic expected dividend growth rate and learns over time by observing a mean-reverting, hence stationary, dividend-consumption ratio. The key mechanism differing from earlier works is the mean-reversion in the dividend-consumption ratio which reduces the learning generated positive covariance between the realized dividend and the expected future dividends, and causes the effect of learning on the stock volatility to be limited, and even negative when the dividend-consumption ratio is relatively low. The third chapter of my thesis is based on my work with Suleyman Basak in which we develop a dynamic model of belief dispersion to simultaneously explain empirical regularities in a stock price, its mean return, volatility, and trading volume. In our analysis, we construct measures for the average bias and dispersion in beliefs, and show that the stock price increases in belief dispersion while its mean return decreases when the economy is optimistic, and vice versa when pessimistic. We also find the presence of belief dispersion generates excess stock volatility, non-trivial trading volume, and a positive relation between these two quantities.