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Value or Growth? The Pricing of Idiosyncratic Cash-Flow Risk with Heterogeneous Beliefs

  • Michael Gallmeyer The McIntire School of Commerce, University of Virginia
  • Hogyu Jhang College of Business Administration, Chungnam National University
  • Hwagyun Kim Mays Business School, Texas A&M University
We study a continuous-time pure exchange economy where idiosyncratic cash flow risks are priced via investors¡¯ heterogeneous beliefs. Investors perceive idiosyncratic cash flow risks differently through heterogeneous subjective mean growth rates on a firm¡¯s cash flow. This impacts equilibrium quantities. Our model shows that idiosyncratic cash flow shocks priced through belief differences can explain cross-sectional variations in stock returns and cash flows. Quantitative results show that a value premium arises, as value stocks have higher idiosyncratic cash-flow volatilities, lower average cash flows, and higher belief differences, which is empirically supported. A growth premium prevails without belief differences.

  • Michael Gallmeyer
  • Hogyu Jhang
  • Hwagyun Kim
We study a continuous-time pure exchange economy where idiosyncratic cash flow risks are priced via investors¡¯ heterogeneous beliefs. Investors perceive idiosyncratic cash flow risks differently through heterogeneous subjective mean growth rates on a firm¡¯s cash flow. This impacts equilibrium quantities. Our model shows that idiosyncratic cash flow shocks priced through belief differences can explain cross-sectional variations in stock returns and cash flows. Quantitative results show that a value premium arises, as value stocks have higher idiosyncratic cash-flow volatilities, lower average cash flows, and higher belief differences, which is empirically supported. A growth premium prevails without belief differences.
idiosyncratic cash-flow risk,heterogeneous beliefs,general equilibrium,crosssectionof stock returns,habit formation,the value premium.