Abstract：This paper investigates the impact of idiosyncratic risk on expected returns with a consideration of heterogeneous belief. By introducing heterogeneous belief and short selling constraint into traditional Merton’s models, the paper discusses the relationship between idiosyncratic volatilities and expected returns. Our model shows that when investors fail to achieve full diversification, idiosyncratic volatilities enter into the pricing equation and are positively related with expected returns even if heterogeneous belief is considered.
2012, Vol. 1 
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