The Effect of Changing Expectations Upon Stock Returns

The relationship between heterogeneous expectations on the part of investors with respect to a security's future return and asset prices is an area of increasing interest in finance. Theoretical examples include Miller 14, Williams 23, and Jarrow 8. Empirical examples include Bart and Masse 1 and Peterson and Peterson 18. Miller, Bart and Masse, and Peterson and Peterson address issues related to whether an increase in divergence of opinion will lead to an increase in an asset's price. Unfortunately, little is known of how different types of changes in investors' probability distributions of returns influence asset returns. An even more basic problem is that it is not clear what is meant in terms of investor probability distributions when it is said that divergence of opinion increases or decreases. The answer to this problem has important implications for understanding equilibrium price.