Abstract
This paper studies the effects of investors’ heterogeneous beliefs on the trading volume, price volatility, and liquidity of stocks. Following Kurz and Motolese (2008), we propose a simple theoretical model to show that the equilibrium stock price is linearly and positively correlated with market belief (investors’ average belief) about stock future payoffs. Further, it is shown in this paper that when market belief is more volatile, trading volume and liquidity decline while price volatility increases. Using the analyst forecast data on quarterly earnings per share provided by the Institutional Brokers’ Estimate System, we obtain empirical results which support the theoretically predicted relations between the volatility of market belief about stock future payoffs and the trading volume, price volatility, and liquidity of underlying stocks, and these empirical results are robust to various methods of estimating market belief and its volatility and to alternative illiquidity measures.
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