Essays on asset pricing under heterogeneous beliefs

My dissertation examines asset prices in perfect markets where economic agents have heterogeneous beliefs and are subject to behavioral psychology. Under no arbitrage, I fully characterize the equilibrium consumption, portfolio choices, asset prices, and the interest rates for those economies. Chapter 1 helps explain the risk premium puzzle and the excess volatility puzzle. Agents are overconfident and have heterogeneous beliefs about the future asset prices. Parameter uncertainty makes agents become more risk-averse and reduce risky investments. Such effects need to be compensated by a higher risk premium and a more volatile asset price. When agents also care about their intertemporal wealth levels regarding social status, they will become even more risk-averse. The heterogeneous beliefs affect the equilibrium through agents' perceived disagreement risk, and affect their hedging demands against any unfavorable estimation errors. Overconfidence in learning will increase the disagreement risk and hence price volatility.; Alternatively, agents may concern about the changes in wealth rather than the wealth itself. Chapter 2 shows that loss aversion helps explain the limited stock market participation puzzle. With high loss aversion, a loss-averse agent behaves like a portfolio insurer when facing gains, and is subject to break-even effect when facing losses. Contrast with low loss aversion, she is subject to house-money effect when facing gains, and tends to sell stocks when facing losses. A loss-averse agent will not participate in the market unless risk premium is very high, or she is not quite loss-averse with a profit cushion. The equilibrium price schedules are typically nonmonotonic, and discontinuous. When agents withdraw from the market, the market crashes.; Chapter 3 extends the analysis to an open monetary economy. I show that heterogeneous beliefs helps explain the home bias puzzle. Countries' demands for foreign risky securities are backward-bending depending on the relative sizes of price risk and exchange rate risk. Countries' underconfidence and low expectations on the returns of foreign investments, high exchange rate risk, and very weak home currency today all contribute to the deterrence of foreign investment. Money will affect real quantities in the equilibrium and hence not neutral due to disagreement risk and incomplete markets.