Equity Markets in a Divergent Expectations World: A Bridge between Theory and Reality

Important academic analyses of price formation in the equity markets are based on the assumption that participants have homogeneous expectations. Relaxing this assumption, we deal with the reality that, because information sets are typically large and complex, investors have divergent expectations. In a divergent-expectation environment, price discovery is a dynamic, complex, noisy process that involves elevated short-period price volatility and return autocorrelations of first and higher orders. In the dynamic environment of divergent expectations and noisy price discovery, liquidity is impaired and market structure matters.