HETEROGENEOUS PRIOR BELIEFS. ANALYZING INVESTORS’ CHOICES THROUGH A BINOMIAL TREE STRUCTURE.

Abstract

Heterogeneity arises because traders have different distribution assumptions about an informed trader’s private signal. I construct a model based initially on a two-period exchange economy with complete markets and heterogeneous prior beliefs, in which we can identify two different categories of traders: the informed ones who know the probability distributions of random shocks and the uninformed who aren’t able to determine the probability π. I used the binomial tree structure to analyze investor choices and to understand the influence that previous choices have on subsequent ones using, as variables for this analysis in the different time intervals, the price q of the securities and the probabilities associated with the realizations of the random variables. I then report some examples through Matlab using as variables the price q, the probabilities π, a function α and the wealths w of the traders to investigate the ability of the uninformed traders to make up for the lack of information.