A Temporary Equilibrium Model of Asset Pricing

This paper examines a decision-making problem of rational agents with risk averse utilities in the financial market both in statics and in dynamics. In the financial market there are two securities, one risky security and one riskless bond, and a continuum of investors with heterogeneous preferences, endowments, and beliefs. Given that investors' beliefs are described by gamma distribution with different parameters, predictions are made about competitive equilibrium asset prices and the sizes of groups of traders and of their positions in the market. The dynamic extension of the model shows how traders' beliefs can be updated by Bayes' rule. This rational updating determines the next period investors' beliefs and predicts future equilibrium asset prices and the positions of traders in the market.