Heterogeneous Expectations, Restrictions on Short Sales, and Equilibrium Asset Prices


  • Assistant Professor of Finance Cornell University. Helpful comments from Fischer Black, Donald Lessard, Robert Merton, Franco Modigliani, Stewart Myers, the Finance theory workshop at MIT, and Michael J. Brennan are gratefully acknowledged.


Under heterogeneous expectations, the mean–variance model of capital market equilibrium is employed to determine the effect restricting short sales has on equilibrium asset prices. Two equivalent markets differing only with respect to short sale restrictions are compared. It is shown that, in general, risky asset prices can either rise or fall due to short sale constraints. However, under a homogeneity of beliefs for the covariance matrix of future prices, short sale constraints will only increase risky asset prices.