Authors: Ke Du (IFS of SWUFE)，Yishu Fu (China Financial Research Center of Southwest University of Finance and Economics), Zhenjiang Qin (School of Business Administration, University of Macau, China), Shuoxun Zhang (Department of finance, School of economics, Xiamen University of China and Wang Yan'an Institute of Economics)
Abstract: We investigate the impacts of speculation on stock price and return volatility in a framework with regime shifting. We find that greater difference in beliefs about the probability of bad state leads to higher stock prices. The intuition is that in periods of higher dispersion of beliefs, the investors perceive greater speculative opportunities, leading to increased demands and valuations of the stock. When investors agree with each other on the state of dividend growth, they have a stronger incentive to invest in the riskless bond, when becoming more pessimistic about the dividend growth. As a result, the demand and the valuations of stock decrease. Moreover, higher level of heterogeneity in beliefs gives rise to higher volatility of the stock returns, even in the absence of dividend shocks. Furthermore, with homogeneous beliefs, return volatility with respect to investors鈥beliefs follows an inverted-U shape.
