State-price densities under heterogeneous beliefs, the smile effect, and implied risk aversion |
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Authors: | Alexandre Ziegler |
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Affiliation: | Ecole des HEC, University of Lausanne, BFSH 1, 1015 Lausanne-Dorigny, Switzerland |
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Abstract: | It has been widely noted in the empirical literature that state-price densities implicit in financial asset prices are not log-normal. This paper shows that this phenomenon can be caused by heterogeneity in investors’ beliefs. It derives the state-price density under heterogeneous beliefs in closed form and demonstrates that heterogeneous beliefs can give rise to multimodal state-price densities. Consequences for the “smile effect” in implied option volatility and for measures of risk aversion inferred from empirical state-price densities are discussed. |
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Keywords: | G12 G13 G14 |
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