Essays on Heterogeneous Beliefs in Financial Markets

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In this thesis, I investigate how the disagreements among market participants can affect markets in various settings. In the first chapter, I study how market participants with heterogeneous beliefs and non-commitment can create and manage counterparty risk in a sequentially and bilaterally traded market. I find that the equilibrium price may not always reflect counterparty risk due to risk-management efforts by market participants. Even when there is no default in equilibrium, market participants cannot attain the best allocations since risk-management is costly. In the second chapter, I study disagreements among market participants under more general belief structures. Here, I employ the collateral equilibrium framework to study the how the disagreements can affect equilibrium pricing of assets and derivatives. I provide sufficient conditions for bubble to exist in equilibrium prices. Moreover, I find that certain types of disagreements can also generate volatility smirks in options. In chapter three, I study asynchronized trading among market participants in presence of a growing asset bubble. Market participants disagree on the starting date of an exogenous asset bubble and decide when to exit the market. I also introduce a large market participant alongside numerous infinitesimal market participants to study their interactions and the mechanism of the bursting an asset bubble. I find results in contrast to those in the currency attack literature. The market participants in this setting stand to benefit from a growing asset bubble whereas the market participants in the currency attack literature only benefit if an attack is successful.

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  • 10/14/2019
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