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Speculative Investor Behavior in a Stock Market With Heterog, M. Harrison & D. Kreps

Speculative Investor Behavior in a Stock Market With Heterog, M. Harrison & D. Kreps

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SpeculativeInvestorBehaviorinaStockMarketwithHeterogeneousExpectations
STOR
J.MichaelHarrison,DavidM.Kreps
TheQuarterlyJournalofEconomics,
Volume92,Issue2(May,1978),323-336.
StableURL:http://links.jstor.org/sici?sici=0033-5533%28197805%2992%3A2%3C323%3ASIBIAS%3E2.0.CO%3B2-YYouruseoftheJSTORarchiveindicatesyouracceptanceofJSTOR'sTermsandConditionsofUse,availableathttp://www.jstor.org/aboutiterms.html.JSTOR'sTermsandConditionsofUseprovides,inpart,thatunlessyouhaveobtainedpriorpermission,youmaynotdownloadanentireissueofajournalormultiplecopiesofarticles,andyoumayusecontentintheJSTORarchiveonlyforyourpersonal,non-commercialuse.EachcopyofanypartofaJSTORtransmissionmustcontainthesamecopyrightnoticethatappearsonthescreenorprintedpageofsuchtransmission.
TheQuarterlyJournalofEconomics
ispublishedbyTheMITPress.Pleasecontactthepublisherforfurtherpermissionsregardingtheuseofthiswork.Publishercontactinformationmaybeobtainedathttp://www.jstor.org/journals/mitpress.html.
TheQuarterlyJournalofEconomics
©1978TheMITPressJSTORandtheJSTORlogoaretrademarksofJSTOR,andareRegisteredintheU.S.PatentandTrademarkOffice.FormoreinformationonJSTORcontactjstor-info@umich.edu.©2002JSTORhttp://www.jstor.org/SatJun2200:14:432002
 
SPECULATIVEINVESTORBEHAVIORINASTOCKMARKETWITHHETEROGENEOUSEXPECTATIONS*
J.
MICHAELHARRISONANDDAVIDM.KREPSI.
Introduction,
323.-11.
Formulation,
325.-lll.
Anexample,
326.-IV.
Consistentpriceschemes,
328.-V.
Backtotheexample,
332.-VI.
Relaxingtheassumptions,
333.-VII.
Concludingremarks,
334.
1.
INTRODUCTION
Consideracommonstockthatpaysdividendsatadiscretese-quenceoffuturetimes:
t
=
1,2,....Takingallotherpricesandtherandomprocessthatdeterminesfuturedividendsasexogenouslygiven,wecanaskwhatwillbethepriceofthestock?Inaworldwithacompletesetofcontingencyclaimsmarkets,inwhicheveryinvestorcanbuyandsellwithoutrestriction,theanswerisgivenbyarbitrage.Let
ddXt)
denotethedividendthatwillbepaidattime
t
ifcontin-gency
Xt
prevails,andlet
f3t(Xt)
denotethecurrent
(t
=
0)priceofaonedollarclaimpayableattime
t
ifcontingency
Xt
prevails.Thenthecurrentstockpricemustbe
~t~Xtf3dXt)dt(Xt).
Furthermore,insuchaworlditmakesnodifferencewhethermarketsreopenafterinitialtrading.Ifmarketsweretoreopen,investorswouldbecontenttomaintainthepositionstheyobtainedinitially(cf.Arrow,1968).Thesituationbecomesmorecomplicatedifmarketsareimperfectorincompleteorboth.Ownershipofthestockimpliesnotonlyown-ershipofadividendstreambutalsotherighttosellthatdividendstreamatafuturedate.Investorsmaybeunableinitiallytoachievepositionswithwhichtheywillbeforevercontent,andthusthecurrentstockpricemaybeaffectedbywhetherornotmarketswillreopeninthefuture.
If
theydoreopen,a
speculativephenomenon
mayappear.Aninvestormaybuythestocknowsoastosellitlaterformorethanhethinksitisactuallyworth,therebyreapingcapitalgains.Thispossibilityofspeculativeprofitswillthenbereflectedinthecurrentprice.Keynes(1931,Ch.12)attributesprimaryimportancetothisphenomenon(andgoesontosuggestthatitmightbebetterifmarketsneverreopened).Wesaythatinvestorsexhibit
speculativebehavior
iftherighttoresellastockmakesthemwillingtopaymoreforitthantheywouldpayifobligedtoholditforever.Thisphenomenonwillnotoccurin
*
OurresearchwaspartiallysupportedbyagrantfromtheAtlanticRichfieldFoundationtotheGraduateSchoolofBusiness,StanfordUniversity.
©1978bythePresidentandFellowsofHarvardCollege.PublishedbyJohnWiley
&
Sons,Inc.
QuarterlyJournalofEconomics,
May19780033-5533/78/0092-0323$01.00
 
324
QUARTERLYJOURNALOFECONOMICS
aworldwithoneperiodremaining(asinthecapital-asset-pricingmodel),inaworldwhereallinvestorsareidentical,orinaworldwithcompleteandperfectcontingencyclaimsmarkets.Ourcharacter-izationofspeculativebehaviorisnotintendedtobeall-inclusive,norisitintendedtotranscendourpartial-equilibriumframework.FordifferentdefinitionsandanalysesseeFeiger(1976)andHirshleifer(1975).InSectionIIwepresentanextremelysimplemodel(ofthemarketforasinglestock)inwhichthespeculativephenomenoncanbesharplyseen.Thekeyelementofourmodelistheexistenceofheterogeneousexpectationswithinthecommunityofpotentialin-vestors.Beyondthisreasonablesupposition,veryrestrictiveas-sumptionsaremade.Investorsarepartitionedintoafinitenumberofinternallyhomogeneousclasses,eachclasshaving(whatamountsto)infinitecollectivewealth.Allinvestorshaveaccesstothesamesubstantiveeconomicinformation(althoughmembersofdifferentclassesmayarriveatdifferentsubjectiveprobabilityassessmentsonthebasisofthatinformation).Membersofeachclassarerisk-neutral,sothatanyincomestreamisvaluedatits(subjective)expectedpresentworth.Fornotationalconvenienceonly(seeSectionV)thediscountfactoristakentobeknownandconstant.Mostimportantly,shortsalesofthestockinquestionareforbidden.InSectionIIIwegiveasimplenumericalexamplethatillustratesthedelicatenatureofpriceequilibriuminourmodel.
It
isshownhowmembersofoneclassbidupthepriceofthestockinanticipationoffutureopportunitiesforsellingittomembersofotherclasses,athigherpricesthantheythemselveswouldbewillingtopay.Itisseenthat,ifanequilibriumpriceistobefound,itmustexceedwhatanyclasswouldbewillingtopayforthestockifobligedtoholditfor-ever.Withthismotivation,wereturntothegeneralmodelinSectionIV.WeadaptRadner's(1972)criterionforpriceequilibriumtothepartial-equilibriumcontextofourmodel,andapricescheme(orpricesystem)thatmeetsthiscriterioniscalled
consistent.
Roughly,apriceschemeisconsistentifitdoesnotallowanyinvestortogarnerex-cessiveexpectedreturnthroughadroitspeculation.Standardmath-ematicalresultsarecitedtoestablishthatconsistencyisequivalenttoasimplemartingale-likepropertyforthepricesandthatthereexistsaminimalconsistentpricescheme.Typically,theminimalconsistentpricewillexceedeveryinvestor'sexpectedpresentworthoffuturedividends.Investorsarewillingtopaya"speculativepre-mium"becauseofanticipatedcapitalgains.Theredoexistnonmi-

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