Essays on disagreement in financial markets

Economists have long recognized the importance of disagreement as an important component of the behavior of observed market prices. I construct a heterogeneous agent, general equilibrium, disagreement model; the laboratory chosen is a continuous-time financial market in which certain key parameters affecting fundamentals are unobservable.; I begin with an inquiry into the relationship between disagreement and stock return volatility. Agents trade risk by exchanging a risk-free asset and dividend-paying risky asset. The dividend is modelled as a diffusion process whose drift is unobservable, but is known to follow a two-state Markov switching process. Agents form expectations over the drift but have heterogeneous priors over its initial distribution, thus inducing persistent disagreement. Agents that disagree will attempt to hedge against adverse changes of aggregate opinion and this additional hedging demand will show up in each agent's perceived risk premium. A decomposition of the stock return volatility is obtained using the Malliavin calculus in which belief dispersion is shown to be an important component.; Long-term consumption and investment decisions depend on one's knowledge of the processes governing key economic variables. My second chapter solves the optimal consumption and portfolio choice problem faced by heterogeneous investors who disagree on the growth rate of the aggregate consumption process. I demonstrate that the portfolio holdings consists of three terms: a myopic demand and two hedging demands. The two hedging terms arise as agents desire insurance against adverse state variable fluctuations, and are affected by disagreement.; The third chapter explores the quantitative implications of the theory developed in chapters 1 and 2 using Monte Carlo simulation. Various types of disagreement are considered including disagreement in the mean level of the fundamental grown rate and disagreement in the persistence of each regime. The magnitude of the impact of disagreement on stock returns, consumption and investment decisions is estimated from consumption and financial market data, and compared with the simulation results.