Equilibrium Asset Pricing Under Heterogeneous Information
Bruno Biais, Toulouse University and CEPR
Peter Bossaerts, California Institute of Technology and CEPR
Chester Spatt, Carnegie Mellon University

The authors theoretically and empirically analyze the implications of heterogeneous information for equilibrium asset pricing and portfolio choice. The theoretical framework, directly inspired by Admati (1985), implies that with partial information aggregation, portfolio separation fails, buy-and-hold strategies are not optimal, and investors should structure their portfolios using the information contained in prices in order to cope with winner’s curse problems. They implement empirically such a price-contingent portfolio allocation strategy and show that it outperforms economically and statistically the passive/indexing buy-and-hold strategy. They thus demonstrate that prices reveal information, in contrast with the homogeneous information CAPM, but only partially, consistent with a Noisy Rational Expectations Equilibrium. The success of their price-contingent strategy does not proxy for the success of trading strategies based purely on historical performance, such as momentum investment. (Accepted Summer, 2003)

Members engaged in investment management-either as managers or sponsors-need to understand well the implications of heterogeneous information for portfolio choice. Simple theories based on common information such as the CAPM suggest that prices reveal no information about future returns. With heterogeneous, prices reveal information so that conditioning portfolio choice on price can produce enhanced returns relative to passive strategies.