Abstract
We develop a dynamic asset pricing model with heterogeneously informed agents. Unlike previous research, we focus on the general case where differential information leads to the problem of “forecasting the forecasts of others” and to non-trivial dynamics of higher order expectations. In particular, we prove that the model does not admit a finite number of state variables. Using numerical analysis, we compare equilibria characterized by identical fundamentals but different information structure. We demonstrate that the distribution of information has substantial impact on equilibrium prices and returns. In particular, we show that asymmetric information can generate momentum in returns and high trading volume.
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