Portfolio efficiency under heterogeneous beliefs

World Scientific
Publication Type:
Recent Advances in Financial Engineering, 2010, 1st, pp. 127 - 156
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In the standard mean variance (MV) capital asset pricing model (CAPM) with homogeneous beliefs, the optimal portfolios of investors are MV efficient. It is expected that this is no longer true in general when investors have heterogeneous beliefs in the means. and variances/covariances of asset returns. This paper extends the s.tandard Black's zero-beta CAPM to incorporate heterogeneous beliefs and verifies that lhe subjectively optima) portfolios of heterogeneous investors are MV inefficient in generaL The paper then demonstrates that the traditional geometric relation of the mean variance frontiers with and Without the riskless asset under homogeneous beliefs does not hold in general under heterogelleous beliefs. The paper further examines the impact of biased beliefs among investors on the MY efficiency of their optimal portfolios. The results provide some explanalions on the risk premium puzzle, Miller's hypothesis, and underperfonnance of managed funds.
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