Diverse Beliefs

TL;DR

This paper introduces a comprehensive framework for analyzing diverse beliefs in dynamic economies, revealing insights into rational overconfidence, trade volume effects, Keynesian phenomena, and the natural emergence of bubbles and crashes.

Contribution

It provides a unified approach to studying diverse beliefs, simplifying the derivation of equilibrium conditions and enabling analysis of complex economic phenomena.

Findings

Rational overconfidence arises with diverse beliefs.

Trade volume effects can be effectively modeled.

Bubbles and crashes naturally emerge from the framework.

Abstract

This paper presents a general framework for studying diverse beliefs in dynamic economies. Within this general framework, the characterization of a central-planner general equilbrium turns out to be very easy to derive, and leads to a range of interesting applications. We show how for an economy with log investors holding diverse beliefs, rational overconfidence is to be expected; volume-of-trade effects are effectively modelled; the Keynesian `beauty contest' can be modelled and analysed; and bubbles and crashes arise naturally. We remark that models where agents receive private information can formally be considered as models of diverse beliefs.