Risk, Uncertainty, and Divergence of Opinion (1977) Oct 11 2017 13:41 languageMoneyScience
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Edward M. Miller
The Journal of Finance, Volume 32, Issue 4 (Sep., 1977)
The theory of investor behaviour in a world on uncertainty has been set out by several writers including Sharpe (1964) and Lintner (1965). A key assumption of the now standard capital asset model is what Sharpe calls homothetic expectations. All investors are assumed to have identical estimates of the expected retrun and probability distribution of return from all securities. However it is implausible to assume that although the future is very uncertain, and forecasts are very difficult to make, that somnehow everyone makes identical estimates of the return and risk from every security. In practice the very concept of uncertainty implies that reasonable men may differ in their forecasts.
This paper will explore some of the implications of a market with restricted short selling in which investors have differing estimates of the returns from investing in a risky security. Explanations will be offered for the very low returns on the stocks in the higest risk classes, the poor long run results on new issues of stocks, the presence of discounts from net value for closed end investment companies, and the lower than predicted rates of return for stocks with high systematic risk.