Speculative Trading with Rational Beliefs and Endogenous Uncertainty

This paper introduces the framework of rational beliefs of Kurz(1994), which makes the assumptions of heterogeneous beliefs of Harrison and Kreps (1978) and Morris (1996) more plausible. Agents hold diverse beliefs that are quot;rationalquot; in the sense of being compatible with ample observed data. In a non-stationary environment the agents only learn about the stationary measure of observed data, but their beliefs can remain non-stationary and diverse. Speculative trading then stems from disagreements among traders. In a Markovian framework of dividends and beliefs, we obtain analytical results to show how the speculative premium depends on the extent of heterogeneity of beliefs. In addition, we demonstrate that there exists a unique Rational Belief Equilibrium (RBE) generically with endogenous uncertainty (as defined by Kurz andWu, 1996) and that the RBE price is higher than the rational expectation equilibrium price (REE) under some general conditions