HETEROGENEOUS BELIEFS, WEALTH DYNAMICS, AND ASSET PRICES

Abstract

This thesis synthesizes three papers examining how heterogeneous beliefs drive wealth dynamics and shape asset prices in recursive utility settings. Across models, belief heterogeneity—arising from learning, overreaction, or different priors—generates persistent variation in consumption shares, risk premia, and return predictability. The first paper considers a two-agent economy in which the persistent component of aggregate consumption growth is unobservable, and agents form beliefs via Bayesian learning. Preferences are characterized by generalized recursive smooth ambiguity utility, capturing aversion to both risk and model uncertainty. When the elasticity of intertemporal substitution is greater than one, ambiguity aversion interacts with state uncertainty to generate an endogenous uncertainty sharing motive, enabling long-run survival of both agents despite belief disagreement. The model produces time-varying price-dividend ratios, explained by agents’ evolving welfare weights and heterogeneous beliefs. The model further shows that the interplay between ambiguity aversion and preference parameters governs both survival dynamics and asset pricing implications. The second paper introduces diagnostic expectations, whereby agents overreact to signals about long-run growth. Differences in overreaction intensity generate persistent heterogeneity in beliefs and lead to shifting consumption shares over time. The model amplifies the equity risk premium, depresses the risk-free rate, and highlights how belief distortions affect equilibrium allocations and asset returns under recursive preferences. The third paper examines how belief heterogeneity affects the term structure of interest rates. Disagreement induces speculation and intertemporal risk sharing, generating endogenous wealth redistribution and a time-varying bond risk premium. Despite divergent beliefs, both agents survive. The model accounts for key empirical patterns in bond markets, such as an upward-sloping nominal yield curve, non-zero skewness of bond yield, and state-dependent return predictability. Together, these papers demonstrate that belief heterogeneity is a central mechanism linking macroeconomic uncertainty, wealth dynamics, and asset pricing.

Date of Award	29 Oct 2025
Original language	English
Awarding Institution	The University of Manchester
Supervisor	Hening Liu (Main Supervisor), Chi-Yang Tsou (Co Supervisor) & Alex Taylor (Co Supervisor)