An intertemporal capital asset pricing model with heterogeneous expectations

Abstract

This paper extends the intertemporal capital asset pricing model (ICAPM) to integrate the heterogeneous trading behavior of three groups of investors; rational utility maximizers, positive feedback, or momentum, traders, and fundamental traders. Using several contemporary fundamental factors to proxy for the latter of these investors’ trading patterns, the interaction of these three groups of investors is explored in the G-7 markets using monthly stock market prices. There is no evidence that positive feedback traders are present in the sample data. Fundamental traders are however observable. This finding suggests that although positive feedback traders may drive stock prices in the short-run, as is typically observed in higher frequency data, fundamental traders likely play a role in pushing prices back to their fundamental value in the longer-run.