Non-Equivalent Beliefs and Subjective Equilibrium Bubbles

TL;DR

This paper introduces a dynamic equilibrium model with agents holding strongly heterogeneous beliefs about zero probability events, demonstrating that such belief disagreements can naturally generate subjective asset price bubbles without additional trade restrictions.

Contribution

It is the first to show equilibrium existence in models with strong belief heterogeneity and nullset disagreements, linking these to the emergence of subjective bubbles.

Findings

Equilibrium exists despite strong belief heterogeneity.

Disagreement about nullsets leads to subjective asset bubbles.

Bubbles form without extra trade restrictions beyond solvency constraints.

Abstract

This paper develops a dynamic equilibrium model where agents exhibit a strong form of belief heterogeneity: they disagree about zero probability events. It is shown that, somewhat surprisingly, equilibrium exists in this setting, and that the disagreement about nullsets naturally leads to equilibrium asset pricing bubbles. The bubbles are subjective in the sense that they are perceived by some but not necessarily all agents. In contrast to existing models, bubbles arise with no restrictions on trade beyond a standard solvency constraint.