ASSET PRICES AND TRADING VOLUME IN A BEAUTY CONTEST

Speculators buy an asset hoping to sell it later to investors with hig her private valuations. If agents are uncertain about the distribution of private valuations and about the beliefs of others about this dist ribution, a beauty contest with an infinite hierarchy of beliefs arise s. Under Harsanyi's assumption of a common prior the infinite beliefs hierarchy is readily solved using Bayes' law. This paper shows that co mmon knowledge of the ''beliefs formation rule,'' mapping the private valuation of each agent into his first-order belief, also simplifies t he beliefs hierarchy while allowing for disagreement among agents. We analyse the resulting speculation in a stylized asset market. Several statistics, computed only from readily observable quote, return and vo lume data, are evaluated in terms of their power to discriminate betwe en genuine disagreement and the Harsanyian case. Only statistics that relate volume and volatility, or volume and changes in best offers, ha ve the necessary discriminatory power.