“Value or Growth? The Pricing of Idiosyncratic Cash-Flow Risk with Heterogeneous Beliefs” by Michael Gallmeyer
University of Virginia
Texas A&M University
We study a continuous-time pure exchange economy where idiosyncratic cash ow risks are priced via investors' heterogeneous beliefs. Investors perceive idiosyncratic cash ow risks differently through heterogeneous subjective mean growth rates on a firm's cash ow. This impacts equilibrium quantities. Our model shows that idiosyncratic cash ow 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-ow volatilities, lower average cash flows, and higher belief differences, which is empirically supported. A growth premium prevails without belief differences.