The formation of share market prices under heterogeneous beliefs and common knowledge

TL;DR

This paper develops a dynamic model of share price formation that incorporates heterogeneous beliefs, social sentiment, and the evolution of individual and collective opinions, providing insights into market exuberance.

Contribution

It introduces a novel framework that relaxes the assumption of a single true value, modeling price formation through social and individual belief dynamics.

Findings

Market prices are influenced by heterogeneous beliefs and social mood.

The model explains market exuberance as an emergent property of collective opinion dynamics.

Price formation cannot be reduced to individual beliefs alone.

Abstract

Financial economic models often assume that investors know (or agree on) the fundamental value of the shares of the firm, easing the passage from the individual to the collective dimension of the financial system generated by the Share Exchange over time. Our model relaxes that heroic assumption of one unique "true value" and deals with the formation of share market prices through the dynamic formation of individual and social opinions (or beliefs) based upon a fundamental signal of economic performance and position of the firm, the forecast revision by heterogeneous individual investors, and their social mood or sentiment about the ongoing state of the market pricing process. Market clearing price formation is then featured by individual and group dynamics that make its collective dimension irreducible to its individual level. This dynamic holistic approach can be applied to better understand the market exuberance generated by the Share Exchange over time.