We propose a continuous-time model of trading among risk-neutral agents with heterogeneous beliefs. Agents face quadratic costs-of-carry on their positions and as a consequence, their marginal valuation of the asset decreases when the magnitude of their position increases , as it would be the case for risk-averse agents. In the equilibrium models of investors with heterogeneous beliefs that followed the original work by Harrison and Kreps , investors are risk-neutral, short-selling is prohibited and agents face a constant marginal cost of carrying positions. The resulting resale option guarantees that the equilibrium price exceeds the price of the asset in a static buy-and-hold model where speculation is ruled out . Our model features three main novelties. First, increasing marginal costs entail that the price depends on the exogenous supply. Second, in addition to the resale option, agents may also value an option to delay, and this may cause the market to equilibrate \emph{below the static buy-and-hold price. Third, we introduce the possibility of short-selling ; then the resale option for agents with short positions partly compensates the resale option for long agents. We characterize the unique equilibrium of our model through a Hamilton-Jacobi-Bellman equation of a novel form and use it to derive several comparative statics results .
We propose a continuous-time model of trading with heterogeneous beliefs. Risk-neutral agents face quadratic costs-of-carry on positions and thus their marginal valuations decrease with the size of their position , as it would be the case for risk-averse agents. In the equilibrium models of heterogeneous beliefs that followed Harrison-Kreps , investors are risk-neutral, short-selling is prohibited and agents face constant marginal costs of carrying positions. The resulting resale option guarantees that the price exceeds the price of the asset when speculation is ruled out ; the difference is identified as a bubble. In our model increasing marginal costs entail that the price depends on asset supply. Second, agents also value an option to delay, and this may cause the market to equilibrate \emph{ below the buy-and-hold price. Third, we introduce the possibility of short-selling . A Hamilton-Jacobi-Bellman equation of a novel form quantifies precisely the influence of the costs-of-carry on the price. An unexpected decrease in shorting costs may lead to the collapse of a bubble; this links the financial innovations that facilitated shorting of MBSs to the subsequent collapse of prices .
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among risk-neutral agents
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Agents
Risk-neutral agents
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their positions and as a consequence, their marginal valuation of the asset decreases when the magnitude
positions and thus their marginal valuations decrease with the size
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increases
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investors with
R
the original work by Harrison and Kreps
Harrison-Kreps
R
a constant marginal cost
constant marginal costs
D
equilibrium
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in a static buy-and-hold model where
when
R
. Our model features three main novelties. First,
; the difference is identified as a bubble. In our model
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the exogenous
asset
R
in addition to the resale option, agents may
agents
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below
R
the static
below the
R
; then the resale option for agents with short positions partly compensates the resale option for long agents. We characterize the unique equilibrium of our model through a
. A
R
and use it to derive several comparative statics results
quantifies precisely the influence of the costs-of-carry on the price. An unexpected decrease in shorting costs may lead to the collapse of a bubble; this links the financial innovations that facilitated shorting of MBSs to the subsequent collapse of prices