What Does Financial Market Do? The Formation of Share Market Prices Under Heterogeneous Beliefs and Common Knowledge

Abstract

Financial economic models often assume that investors know (or agree on) the fundamental of the shares of the firm, easing the passage from the individual to the collective dimension of the financial system generated by the Share Exchange over time. Our model relaxes that heroic assumption of one unique true value and deals with the formation of share market prices through the dynamic formation of individual and social opinions (or beliefs) based upon a fundamental signal of economic performance and position of the firm, the forecast revision by heterogeneous individual investors, and their social mood or sentiment about the ongoing state of the market pricing process. Market clearing price formation is then featured by individual and group dynamics that make its collective dimension irreducible to its individual level. This dynamic holistic approach can be applied to better understand the market exuberance generated by the Share Exchange over time.