Ser-Huang Poon and Richard Stapleton
- Published in print:
- 2005
- Published Online:
- July 2005
- ISBN:
- 9780199271443
- eISBN:
- 9780191602559
- Item type:
- book
- Publisher:
- Oxford University Press
- DOI:
- 10.1093/0199271445.001.0001
- Subject:
- Economics and Finance, Financial Economics
Relying on the existence, in a complete market, of a pricing kernel, this book covers the pricing of assets, derivatives, and bonds in a discrete time, complete markets framework. It is primarily ...
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Relying on the existence, in a complete market, of a pricing kernel, this book covers the pricing of assets, derivatives, and bonds in a discrete time, complete markets framework. It is primarily aimed at advanced Masters and PhD students in finance. Topics covered include CAPM, non-marketable background risks, European-style contingent claims as in Black–Scholes and in cases where risk-neutral valuation relationship does not exist, multi-period asset pricing under rational expectations, forward and futures contracts on assets and derivatives, and bond pricing under stochastic interest rates. All the proofs, including a discrete time proof of the Libor market model, are shown explicitly.Less
Relying on the existence, in a complete market, of a pricing kernel, this book covers the pricing of assets, derivatives, and bonds in a discrete time, complete markets framework. It is primarily aimed at advanced Masters and PhD students in finance. Topics covered include CAPM, non-marketable background risks, European-style contingent claims as in Black–Scholes and in cases where risk-neutral valuation relationship does not exist, multi-period asset pricing under rational expectations, forward and futures contracts on assets and derivatives, and bond pricing under stochastic interest rates. All the proofs, including a discrete time proof of the Libor market model, are shown explicitly.
Roman Frydman and Michael D. Goldberg
- Published in print:
- 2013
- Published Online:
- October 2017
- ISBN:
- 9780691155234
- eISBN:
- 9781400846450
- Item type:
- chapter
- Publisher:
- Princeton University Press
- DOI:
- 10.23943/princeton/9780691155234.003.0007
- Subject:
- Economics and Finance, Macro- and Monetary Economics
This chapter considers an alternative approach to economic analysis, Imperfect Knowledge Economics (IKE), and introduces a model of asset prices and risk that has explicit mathematical ...
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This chapter considers an alternative approach to economic analysis, Imperfect Knowledge Economics (IKE), and introduces a model of asset prices and risk that has explicit mathematical microfoundations and yet remains open to nonroutine change. The IKE model consists of representations of individuals' preferences, forecasting behavior, constraints, and decision rules in terms of a set of causal (often called “informational”) variables, which portray the influence of economic policy, institutions, and other features of the social context. It also entails an aggregation rule and processes for the informational variables. The chapter examines irregular swings in asset prices and their relationship to financial risk. It also presents an IKE account of asset price swings before concluding with an analysis of contingent predictions of long swings and their compatibility with rationality.Less
This chapter considers an alternative approach to economic analysis, Imperfect Knowledge Economics (IKE), and introduces a model of asset prices and risk that has explicit mathematical microfoundations and yet remains open to nonroutine change. The IKE model consists of representations of individuals' preferences, forecasting behavior, constraints, and decision rules in terms of a set of causal (often called “informational”) variables, which portray the influence of economic policy, institutions, and other features of the social context. It also entails an aggregation rule and processes for the informational variables. The chapter examines irregular swings in asset prices and their relationship to financial risk. It also presents an IKE account of asset price swings before concluding with an analysis of contingent predictions of long swings and their compatibility with rationality.
Tsuneo Ishikawa
- Published in print:
- 2002
- Published Online:
- November 2003
- ISBN:
- 9780198288626
- eISBN:
- 9780191596469
- Item type:
- chapter
- Publisher:
- Oxford University Press
- DOI:
- 10.1093/019828862X.003.0007
- Subject:
- Economics and Finance, Public and Welfare
This chapter discusses the basic determinants of the generation of wealth and its distribution across households; it has four sections. Section 7.1 considers the life cycle motive as a basis of ...
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This chapter discusses the basic determinants of the generation of wealth and its distribution across households; it has four sections. Section 7.1 considers the life cycle motive as a basis of household saving behaviour, paying particular attention to the role played by the pension annuity system. Section 7.2 discusses the role of education in transmitting wealth between parents and children. Section 7.3 turns to the topic of macroeconomics and looks at how the rate of return is determined in the long term, thereby showing how the theoretical discussions in this book form a general equilibrium framework. Section 7.4 takes up the question of asset and related expectations––asset price fluctuation is considered one of the major causes of generation of huge wealth in the short term, but there are various conflicting dimensions to this problem.Less
This chapter discusses the basic determinants of the generation of wealth and its distribution across households; it has four sections. Section 7.1 considers the life cycle motive as a basis of household saving behaviour, paying particular attention to the role played by the pension annuity system. Section 7.2 discusses the role of education in transmitting wealth between parents and children. Section 7.3 turns to the topic of macroeconomics and looks at how the rate of return is determined in the long term, thereby showing how the theoretical discussions in this book form a general equilibrium framework. Section 7.4 takes up the question of asset and related expectations––asset price fluctuation is considered one of the major causes of generation of huge wealth in the short term, but there are various conflicting dimensions to this problem.
Giovanni Piersanti
- Published in print:
- 2012
- Published Online:
- September 2012
- ISBN:
- 9780199653126
- eISBN:
- 9780191741210
- Item type:
- chapter
- Publisher:
- Oxford University Press
- DOI:
- 10.1093/acprof:oso/9780199653126.003.0005
- Subject:
- Economics and Finance, Macro- and Monetary Economics
In order to describe the path followed by major macroeconomic variable around the time of crises, this chapter examines some dynamic models. It thus shows how the dynamic adjustment path of the ...
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In order to describe the path followed by major macroeconomic variable around the time of crises, this chapter examines some dynamic models. It thus shows how the dynamic adjustment path of the economy associated with exchange rate based stabilization plan can be linked to currency crisis. How expected changes in future government's policies can affect the timing of attacks. How a run on central bank's foreign reserves can emerge in a context of consistent and flexible policy rules. How policymakers can elude speculative attacks by introducing uncertainty into the speculators' decisions. That the domestic currency often stays overvalued for a long period. That large discrete devaluations occur after the peg is abandoned. That the domestic interest rates tend to rise in the run up to the crisis. That speculative runs often occur in a multi-period context giving rise to alternating phases of “tranquillity” and “distress”. That asset price dynamics plays a critical role in triggering a full-blown financial crisis.Less
In order to describe the path followed by major macroeconomic variable around the time of crises, this chapter examines some dynamic models. It thus shows how the dynamic adjustment path of the economy associated with exchange rate based stabilization plan can be linked to currency crisis. How expected changes in future government's policies can affect the timing of attacks. How a run on central bank's foreign reserves can emerge in a context of consistent and flexible policy rules. How policymakers can elude speculative attacks by introducing uncertainty into the speculators' decisions. That the domestic currency often stays overvalued for a long period. That large discrete devaluations occur after the peg is abandoned. That the domestic interest rates tend to rise in the run up to the crisis. That speculative runs often occur in a multi-period context giving rise to alternating phases of “tranquillity” and “distress”. That asset price dynamics plays a critical role in triggering a full-blown financial crisis.
Blake LeBaron
- Published in print:
- 2013
- Published Online:
- October 2017
- ISBN:
- 9780691155234
- eISBN:
- 9781400846450
- Item type:
- chapter
- Publisher:
- Princeton University Press
- DOI:
- 10.23943/princeton/9780691155234.003.0006
- Subject:
- Economics and Finance, Macro- and Monetary Economics
This chapter focuses on heterogeneous gain learning and long swings in asset prices. Many asset prices deviate from their fundamental values, yielding potential long-run predictability. Asset price ...
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This chapter focuses on heterogeneous gain learning and long swings in asset prices. Many asset prices deviate from their fundamental values, yielding potential long-run predictability. Asset price swings can be both short or long in duration, and their time series shows few regular patterns when one analyzes their long-range behavior. This chapter considers an underparameterized learning model with heterogeneous gain parameters and traders using differing perspectives on history. It first provides an overview of the basic model and some benchmark simulation runs before discussing the output of the model compared to actual financial time series. It then describes a range of internal mechanisms of the agents and forecasts in use and how wealth moves across them over time. It shows that learning algorithms appear to be behaving in a predictable fashion, and that interesting dynamics come from how agent wealth selects rules over time. The chapter concludes by addressing some questions for researchers working on learning in financial markets.Less
This chapter focuses on heterogeneous gain learning and long swings in asset prices. Many asset prices deviate from their fundamental values, yielding potential long-run predictability. Asset price swings can be both short or long in duration, and their time series shows few regular patterns when one analyzes their long-range behavior. This chapter considers an underparameterized learning model with heterogeneous gain parameters and traders using differing perspectives on history. It first provides an overview of the basic model and some benchmark simulation runs before discussing the output of the model compared to actual financial time series. It then describes a range of internal mechanisms of the agents and forecasts in use and how wealth moves across them over time. It shows that learning algorithms appear to be behaving in a predictable fashion, and that interesting dynamics come from how agent wealth selects rules over time. The chapter concludes by addressing some questions for researchers working on learning in financial markets.
Markus K. Brunnermeier
- Published in print:
- 2001
- Published Online:
- November 2003
- ISBN:
- 9780198296980
- eISBN:
- 9780191596025
- Item type:
- chapter
- Publisher:
- Oxford University Press
- DOI:
- 10.1093/0198296983.003.0002
- Subject:
- Economics and Finance, Financial Economics
Ch. 2 first exposes the reader to a more tractable notion of common knowledge and the intuition behind proofs of the different no‐trade theorems. The no‐trade theorems state the specific conditions ...
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Ch. 2 first exposes the reader to a more tractable notion of common knowledge and the intuition behind proofs of the different no‐trade theorems. The no‐trade theorems state the specific conditions under which differences in information alone do not lead to trade. The next section sketches out a brief introduction of the basics of asset pricing under symmetric information and highlights the complications that can arise under asymmetric information. Information revelation by prices is closely linked to the security structure and market completeness. The chapter also provides definitions of bubbles and investigates the existence of bubbles under common knowledge. It then illustrates the importance of higher‐order uncertainty for the possible existence of bubbles.Less
Ch. 2 first exposes the reader to a more tractable notion of common knowledge and the intuition behind proofs of the different no‐trade theorems. The no‐trade theorems state the specific conditions under which differences in information alone do not lead to trade. The next section sketches out a brief introduction of the basics of asset pricing under symmetric information and highlights the complications that can arise under asymmetric information. Information revelation by prices is closely linked to the security structure and market completeness. The chapter also provides definitions of bubbles and investigates the existence of bubbles under common knowledge. It then illustrates the importance of higher‐order uncertainty for the possible existence of bubbles.
Darrell Duffie
- Published in print:
- 2012
- Published Online:
- October 2017
- ISBN:
- 9780691138961
- eISBN:
- 9781400840519
- Item type:
- chapter
- Publisher:
- Princeton University Press
- DOI:
- 10.23943/princeton/9780691138961.003.0004
- Subject:
- Economics and Finance, Financial Economics
This chapter presents a simple introduction to asset pricing in over-the-counter markets. Investors search for opportunities to trade and bargain with counterparties, each counterparty being aware ...
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This chapter presents a simple introduction to asset pricing in over-the-counter markets. Investors search for opportunities to trade and bargain with counterparties, each counterparty being aware that failure to conduct a trade could lead to a costly new search for a counterparty. In equilibrium, whenever there is gain from trade, the opportunity to search for a new counterparty is dominated by trading at the equilibrium asset price. The asset price reflects the degree of search frictions. Under conditions, illiquidity premia are higher when counterparties are harder to find, when sellers have less bargaining power, when the fraction of qualified owners is smaller, and when risk aversion, volatility, or hedging demand is larger. Supply shocks cause prices to jump, and then “recover” over time, with a pattern that depends on the degree of search frictions. The chapter shows how the equilibrium bargaining powers of the counterparties are determined by search opportunities using the approach of Rubinstein and Wolinsky (1985).Less
This chapter presents a simple introduction to asset pricing in over-the-counter markets. Investors search for opportunities to trade and bargain with counterparties, each counterparty being aware that failure to conduct a trade could lead to a costly new search for a counterparty. In equilibrium, whenever there is gain from trade, the opportunity to search for a new counterparty is dominated by trading at the equilibrium asset price. The asset price reflects the degree of search frictions. Under conditions, illiquidity premia are higher when counterparties are harder to find, when sellers have less bargaining power, when the fraction of qualified owners is smaller, and when risk aversion, volatility, or hedging demand is larger. Supply shocks cause prices to jump, and then “recover” over time, with a pattern that depends on the degree of search frictions. The chapter shows how the equilibrium bargaining powers of the counterparties are determined by search opportunities using the approach of Rubinstein and Wolinsky (1985).
Roman Frydman and Edmund S. Phelps
- Published in print:
- 2013
- Published Online:
- October 2017
- ISBN:
- 9780691155234
- eISBN:
- 9781400846450
- Item type:
- chapter
- Publisher:
- Princeton University Press
- DOI:
- 10.23943/princeton/9780691155234.003.0001
- Subject:
- Economics and Finance, Macro- and Monetary Economics
This introductory chapter discusses the papers presented at the Center on Capitalism and Society conference held in the fall of 2010. The conference, which commemorated the fortieth anniversary of ...
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This introductory chapter discusses the papers presented at the Center on Capitalism and Society conference held in the fall of 2010. The conference, which commemorated the fortieth anniversary of the Phelps microfoundations volume, featured researchers engaged in developing alternatives to the Rational Expectations Hypothesis (REH). The Phelps volume provided radically new accounts of the comovements of macroeconomic aggregates, including inflation and unemployment, while casting serious doubt on the validity of policy analysis based on then-popular Keynesian macroeconometric models. This chapter considers the various efforts to reinvent macroeconomics that were discussed at the Phelps conference, with a particular focus on non-REH alternatives and their implications for economic analysis. Topics include nonroutine change and imperfect knowledge, expectational coordination and market volatility, autonomous expectations in long swings in asset prices, and the natural rate of unemployment.Less
This introductory chapter discusses the papers presented at the Center on Capitalism and Society conference held in the fall of 2010. The conference, which commemorated the fortieth anniversary of the Phelps microfoundations volume, featured researchers engaged in developing alternatives to the Rational Expectations Hypothesis (REH). The Phelps volume provided radically new accounts of the comovements of macroeconomic aggregates, including inflation and unemployment, while casting serious doubt on the validity of policy analysis based on then-popular Keynesian macroeconometric models. This chapter considers the various efforts to reinvent macroeconomics that were discussed at the Phelps conference, with a particular focus on non-REH alternatives and their implications for economic analysis. Topics include nonroutine change and imperfect knowledge, expectational coordination and market volatility, autonomous expectations in long swings in asset prices, and the natural rate of unemployment.
STEPHEN NICKELL
- Published in print:
- 2007
- Published Online:
- January 2012
- ISBN:
- 9780197263945
- eISBN:
- 9780191734038
- Item type:
- chapter
- Publisher:
- British Academy
- DOI:
- 10.5871/bacad/9780197263945.003.0001
- Subject:
- History, Cultural History
This chapter discusses some of the topics the Bank of England Monetary Policy Committee has spent a lot of time on. It first examines the rapid rise in household debt and its implications for ...
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This chapter discusses some of the topics the Bank of England Monetary Policy Committee has spent a lot of time on. It first examines the rapid rise in household debt and its implications for monetary policy. The next section looks at the role of asset prices in monetary policy, with particular reference to the recent UK housing boom. Finally, the chapter discusses the implications of the switch in the inflation target at the end of 2003.Less
This chapter discusses some of the topics the Bank of England Monetary Policy Committee has spent a lot of time on. It first examines the rapid rise in household debt and its implications for monetary policy. The next section looks at the role of asset prices in monetary policy, with particular reference to the recent UK housing boom. Finally, the chapter discusses the implications of the switch in the inflation target at the end of 2003.
Hendrik S. Houthakker and Peter J. Williamson
- Published in print:
- 1996
- Published Online:
- November 2003
- ISBN:
- 9780195044072
- eISBN:
- 9780199832958
- Item type:
- chapter
- Publisher:
- Oxford University Press
- DOI:
- 10.1093/019504407X.003.0006
- Subject:
- Economics and Finance, Financial Economics
Drawing on Chs. 4 and 5 (which discuss the supply and demand for securities separately), this chapter investigates whether economics has anything helpful to say about the prices of shares and related ...
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Drawing on Chs. 4 and 5 (which discuss the supply and demand for securities separately), this chapter investigates whether economics has anything helpful to say about the prices of shares and related securities by reviewing the most important ideas suggested by economic theory in this area and assessing their usefulness in the real world. In the first two sections, two fairly ancient but still popular models of equity (share) prices are examined, one of which (the steady growth model) views shares as claims to future dividends and the other (the asset model) views them as claims to the underlying net assets (corporate net worth). For the most part, these models look at the shares of individual companies in isolation, not at the market as a whole, and that is their weakness, but the asset model in particular provides important insights into aggregate equity values; as an aside to this discussion it is shown that aggregate dividends have the intriguing feature of being an approximately constant percentage of national income, which means that corporate equities offer protection (though not perfect protection) against inflation as well as participation in the real growth of the economy. The third section looks at the Capital Asset Pricing Model (CAPM) – a discovery of the 1960s that, by considering equities in relation to each other, provided important new insights into the relation between risk and return. A more recent alternative approach known as Arbitrage Pricing Theory is discussed next, and finally there is a section (an appendix) on stock indexes.Less
Drawing on Chs. 4 and 5 (which discuss the supply and demand for securities separately), this chapter investigates whether economics has anything helpful to say about the prices of shares and related securities by reviewing the most important ideas suggested by economic theory in this area and assessing their usefulness in the real world. In the first two sections, two fairly ancient but still popular models of equity (share) prices are examined, one of which (the steady growth model) views shares as claims to future dividends and the other (the asset model) views them as claims to the underlying net assets (corporate net worth). For the most part, these models look at the shares of individual companies in isolation, not at the market as a whole, and that is their weakness, but the asset model in particular provides important insights into aggregate equity values; as an aside to this discussion it is shown that aggregate dividends have the intriguing feature of being an approximately constant percentage of national income, which means that corporate equities offer protection (though not perfect protection) against inflation as well as participation in the real growth of the economy. The third section looks at the Capital Asset Pricing Model (CAPM) – a discovery of the 1960s that, by considering equities in relation to each other, provided important new insights into the relation between risk and return. A more recent alternative approach known as Arbitrage Pricing Theory is discussed next, and finally there is a section (an appendix) on stock indexes.
Gylfi Zoega
- Published in print:
- 2013
- Published Online:
- October 2017
- ISBN:
- 9780691155234
- eISBN:
- 9781400846450
- Item type:
- chapter
- Publisher:
- Princeton University Press
- DOI:
- 10.23943/princeton/9780691155234.003.0010
- Subject:
- Economics and Finance, Macro- and Monetary Economics
This chapter examines the long swings of employment, investment, and asset prices. It highlights one stylized fact that a model of the natural rate of unemployment should be able to take into ...
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This chapter examines the long swings of employment, investment, and asset prices. It highlights one stylized fact that a model of the natural rate of unemployment should be able to take into account: the relationship among unemployment, investment, and share prices that is observed in the data. Although this relationship is often ignored, it provides a justification for some recent models of the natural rate. The chapter first considers a moving natural rate of unemployment before discussing the relationship between the long swings of employment and asset price swings. It then introduces a stripped-down natural rate model that generates a relationship among the natural rate of unemployment, investment, and asset prices. It also describes how financial crises are linked to changes in asset prices, investment, and employment.Less
This chapter examines the long swings of employment, investment, and asset prices. It highlights one stylized fact that a model of the natural rate of unemployment should be able to take into account: the relationship among unemployment, investment, and share prices that is observed in the data. Although this relationship is often ignored, it provides a justification for some recent models of the natural rate. The chapter first considers a moving natural rate of unemployment before discussing the relationship between the long swings of employment and asset price swings. It then introduces a stripped-down natural rate model that generates a relationship among the natural rate of unemployment, investment, and asset prices. It also describes how financial crises are linked to changes in asset prices, investment, and employment.
Claus Munk
- Published in print:
- 2011
- Published Online:
- September 2011
- ISBN:
- 9780199575084
- eISBN:
- 9780191728648
- Item type:
- chapter
- Publisher:
- Oxford University Press
- DOI:
- 10.1093/acprof:oso/9780199575084.003.0004
- Subject:
- Economics and Finance, Financial Economics
The pricing of fixed income securities follows the same general principles as the pricing of all other financial assets. This chapter explains some important general concepts and results in asset ...
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The pricing of fixed income securities follows the same general principles as the pricing of all other financial assets. This chapter explains some important general concepts and results in asset pricing theory that are applied in the rest of the book to the term structure of interest rate and the pricing of fixed income securities. The fundamental concepts discussed are arbitrage, state prices, risk-neutral probability measures, market prices of risk, market completeness, and representative agents. For the popular class of diffusion models, asset prices are shown to satisfy certain partial differential equations.Less
The pricing of fixed income securities follows the same general principles as the pricing of all other financial assets. This chapter explains some important general concepts and results in asset pricing theory that are applied in the rest of the book to the term structure of interest rate and the pricing of fixed income securities. The fundamental concepts discussed are arbitrage, state prices, risk-neutral probability measures, market prices of risk, market completeness, and representative agents. For the popular class of diffusion models, asset prices are shown to satisfy certain partial differential equations.
Ser-Huang Poon and Richard Stapleton
- Published in print:
- 2005
- Published Online:
- July 2005
- ISBN:
- 9780199271443
- eISBN:
- 9780191602559
- Item type:
- chapter
- Publisher:
- Oxford University Press
- DOI:
- 10.1093/0199271445.003.0003
- Subject:
- Economics and Finance, Financial Economics
‘Option Pricing in a Single-Period Model’ uses the one-period complete markets model to derive forward prices of European-style options relates them to the forward price of the underlying asset. The ...
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‘Option Pricing in a Single-Period Model’ uses the one-period complete markets model to derive forward prices of European-style options relates them to the forward price of the underlying asset. The authors show that the value of the option depends upon the shape of the pricing kernel, and, in particular, on the shape of the asset-specific pricing kernel, ψ(xj). The analysis starts at a general level and then concentrates on an important special case, where the underlying cash flow is lognormal. They establish in this case that a risk-neutral valuation relationship (RNVR) exists between the option price and the price of the underlying asset if the asset-specific pricing kernel, ψ(xj), has the property of constant elasticity. This establishes the well known Black–Scholes equation for the value of an option.Less
‘Option Pricing in a Single-Period Model’ uses the one-period complete markets model to derive forward prices of European-style options relates them to the forward price of the underlying asset. The authors show that the value of the option depends upon the shape of the pricing kernel, and, in particular, on the shape of the asset-specific pricing kernel, ψ(xj). The analysis starts at a general level and then concentrates on an important special case, where the underlying cash flow is lognormal. They establish in this case that a risk-neutral valuation relationship (RNVR) exists between the option price and the price of the underlying asset if the asset-specific pricing kernel, ψ(xj), has the property of constant elasticity. This establishes the well known Black–Scholes equation for the value of an option.
Edmund S. Phelps
- Published in print:
- 2013
- Published Online:
- October 2017
- ISBN:
- 9780691155234
- eISBN:
- 9781400846450
- Item type:
- chapter
- Publisher:
- Princeton University Press
- DOI:
- 10.23943/princeton/9780691155234.003.0009
- Subject:
- Economics and Finance, Macro- and Monetary Economics
This chapter examines indeterminacies in wage and asset price expectations. It first considers what it argues are fatal flaws in Keynesian economics, comparing crude Keynesianism with a crude natural ...
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This chapter examines indeterminacies in wage and asset price expectations. It first considers what it argues are fatal flaws in Keynesian economics, comparing crude Keynesianism with a crude natural rate of unemployment. It then introduces a structuralist model of employment and economic growth that better illuminates the long slump without inflation in the United States. In a structuralist model, nonmonetary forces operate through structural channels to impact the path of employment and its medium-term level (as well as its long-term level). Asset prices, such as housing prices, are expressed in real terms. The chapter describes how structuralist models approaches issues relating to asset prices and wages and concludes by explaining how to think about expectation formation in modern economies—economies of the sort that became the lifetime subject of Frank H. Knight, John Maynard Keynes, and F. A. Hayek.Less
This chapter examines indeterminacies in wage and asset price expectations. It first considers what it argues are fatal flaws in Keynesian economics, comparing crude Keynesianism with a crude natural rate of unemployment. It then introduces a structuralist model of employment and economic growth that better illuminates the long slump without inflation in the United States. In a structuralist model, nonmonetary forces operate through structural channels to impact the path of employment and its medium-term level (as well as its long-term level). Asset prices, such as housing prices, are expressed in real terms. The chapter describes how structuralist models approaches issues relating to asset prices and wages and concludes by explaining how to think about expectation formation in modern economies—economies of the sort that became the lifetime subject of Frank H. Knight, John Maynard Keynes, and F. A. Hayek.
Ser-Huang Poon and Richard Stapleton
- Published in print:
- 2005
- Published Online:
- July 2005
- ISBN:
- 9780199271443
- eISBN:
- 9780191602559
- Item type:
- chapter
- Publisher:
- Oxford University Press
- DOI:
- 10.1093/0199271445.003.0001
- Subject:
- Economics and Finance, Financial Economics
‘Asset Prices in a Single-period Model’ derives asset prices in a one-period model. The authors derive a version of the Capital Asset Pricing Model (CAPM) using a complete market, state-contingent ...
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‘Asset Prices in a Single-period Model’ derives asset prices in a one-period model. The authors derive a version of the Capital Asset Pricing Model (CAPM) using a complete market, state-contingent claims approach. They define the forward pricing kernel and then use the assumption of joint normality of the cash flows and Stein's lemma to establish the CAPM. They then derive the pricing kernel in an equilibrium representative investor model.Less
‘Asset Prices in a Single-period Model’ derives asset prices in a one-period model. The authors derive a version of the Capital Asset Pricing Model (CAPM) using a complete market, state-contingent claims approach. They define the forward pricing kernel and then use the assumption of joint normality of the cash flows and Stein's lemma to establish the CAPM. They then derive the pricing kernel in an equilibrium representative investor model.
Claus Munk
- Published in print:
- 2013
- Published Online:
- May 2013
- ISBN:
- 9780199585496
- eISBN:
- 9780191751790
- Item type:
- book
- Publisher:
- Oxford University Press
- DOI:
- 10.1093/acprof:oso/9780199585496.001.0001
- Subject:
- Economics and Finance, Econometrics
“Financial Asset Pricing Theory” offers a comprehensive overview of the classic and the current research in theoretical asset pricing. Asset pricing is developed around the concept of a state-price ...
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“Financial Asset Pricing Theory” offers a comprehensive overview of the classic and the current research in theoretical asset pricing. Asset pricing is developed around the concept of a state-price deflator which relates the price of any asset to its future (risky) dividends and thus incorporates how to adjust for both time and risk in asset valuation. The willingness of any utility-maximizing investor to shift consumption over time defines a state-price deflator which provides a link between optimal consumption and asset prices that leads to the Consumption-based Capital Asset Pricing Model (CCAPM). A simple version of the CCAPM cannot explain various stylized asset pricing facts, but these asset pricing “puzzles” can be resolved by a number of recent extensions involving habit formation, recursive utility, multiple consumption goods, and long-run consumption risks. Other valuation techniques and modelling approaches (such as factor models, term structure models, risk-neutral valuation, and option pricing models) are explained and related to state-price deflators. The book will serve as a textbook for an advanced course in theoretical financial economics in a PhD or a quantitative Master of Science program. It will also be a useful reference book for researchers and finance professionals. The presentation in the book balances formal mathematical modelling and economic intuition and understanding. Both discrete-time and continuous-time models are covered. The necessary concepts and techniques concerning stochastic processes are carefully explained in a separate chapter so that only limited previous exposure to dynamic finance models is required.Less
“Financial Asset Pricing Theory” offers a comprehensive overview of the classic and the current research in theoretical asset pricing. Asset pricing is developed around the concept of a state-price deflator which relates the price of any asset to its future (risky) dividends and thus incorporates how to adjust for both time and risk in asset valuation. The willingness of any utility-maximizing investor to shift consumption over time defines a state-price deflator which provides a link between optimal consumption and asset prices that leads to the Consumption-based Capital Asset Pricing Model (CCAPM). A simple version of the CCAPM cannot explain various stylized asset pricing facts, but these asset pricing “puzzles” can be resolved by a number of recent extensions involving habit formation, recursive utility, multiple consumption goods, and long-run consumption risks. Other valuation techniques and modelling approaches (such as factor models, term structure models, risk-neutral valuation, and option pricing models) are explained and related to state-price deflators. The book will serve as a textbook for an advanced course in theoretical financial economics in a PhD or a quantitative Master of Science program. It will also be a useful reference book for researchers and finance professionals. The presentation in the book balances formal mathematical modelling and economic intuition and understanding. Both discrete-time and continuous-time models are covered. The necessary concepts and techniques concerning stochastic processes are carefully explained in a separate chapter so that only limited previous exposure to dynamic finance models is required.
LEIGH A. RIDDICK
- Published in print:
- 2012
- Published Online:
- May 2013
- ISBN:
- 9780199754656
- eISBN:
- 9780199979462
- Item type:
- chapter
- Publisher:
- Oxford University Press
- DOI:
- 10.1093/acprof:oso/9780199754656.003.0014
- Subject:
- Economics and Finance, Financial Economics, International
Several factors complicate the tasks of valuing assets in a portfolio and measuring their risk-adjusted performance in an international setting. Chief among these are currency and inflation effects ...
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Several factors complicate the tasks of valuing assets in a portfolio and measuring their risk-adjusted performance in an international setting. Chief among these are currency and inflation effects that arise when investment returns must be translated into a currency other than that in which the return is paid. These complications affect both return and risk and, thus, value. This chapter provides a review of international asset pricing models and their risk-return structure, beginning with the basic international mean-variance model. The discussion then turns to the many mean-variance model extensions, including consumption-based models, models with higher-order statistical moments, and models using conditioning information. The chapter then reviews models based on arbitrage pricing principles or other multifactor approaches that differ from the mean-variance framework. The chapter concludes that more than one model type can be effective in an international setting, but that simplifications that detract from capturing international sources of risk should be avoided.Less
Several factors complicate the tasks of valuing assets in a portfolio and measuring their risk-adjusted performance in an international setting. Chief among these are currency and inflation effects that arise when investment returns must be translated into a currency other than that in which the return is paid. These complications affect both return and risk and, thus, value. This chapter provides a review of international asset pricing models and their risk-return structure, beginning with the basic international mean-variance model. The discussion then turns to the many mean-variance model extensions, including consumption-based models, models with higher-order statistical moments, and models using conditioning information. The chapter then reviews models based on arbitrage pricing principles or other multifactor approaches that differ from the mean-variance framework. The chapter concludes that more than one model type can be effective in an international setting, but that simplifications that detract from capturing international sources of risk should be avoided.
E. Philip Davis
- Published in print:
- 1995
- Published Online:
- November 2003
- ISBN:
- 9780198233312
- eISBN:
- 9780191596124
- Item type:
- chapter
- Publisher:
- Oxford University Press
- DOI:
- 10.1093/0198233310.003.0010
- Subject:
- Economics and Finance, Financial Economics
Chapters 9 and 10 were written for the Second Edition of the book in mid 1994. This chapter seeks to provide further evidence on the importance of the mechanisms of financial fragility and ...
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Chapters 9 and 10 were written for the Second Edition of the book in mid 1994. This chapter seeks to provide further evidence on the importance of the mechanisms of financial fragility and instability, and of the appropriateness of the framework for analysis provided in the book itself, based on experience over the recessionary period of 1990–3. This chapter is structured as follows: in the first section, we assess experience of financial fragility over 1988–93, using as material various indicators at a macroeconomic level. Following the analysis of Ch. 4, a general pattern of financial fragility is sketched and traced in the data for a number of countries. In this context, particular focus is laid on the interrelation between asset prices and credit, as well as the potential importance of moral hazard and adverse selection. The second section complements this analysis by sketching the results of a number of more detailed studies of issues in financial fragility that have been made at a national level, and which are nonetheless considered to have a broader applicability. In the third section, four further periods of systemic risk, namely the banking crises in Finland, Sweden, and Japan, and the collapse of activity in the ECU bond market in 1992, are analysed in the light of the framework for analysis developed in Chs. 5 and 7. The degree to which they confirm the generality of the phenomena outlined earlier in the book is considered in a final part of this section.Less
Chapters 9 and 10 were written for the Second Edition of the book in mid 1994. This chapter seeks to provide further evidence on the importance of the mechanisms of financial fragility and instability, and of the appropriateness of the framework for analysis provided in the book itself, based on experience over the recessionary period of 1990–3. This chapter is structured as follows: in the first section, we assess experience of financial fragility over 1988–93, using as material various indicators at a macroeconomic level. Following the analysis of Ch. 4, a general pattern of financial fragility is sketched and traced in the data for a number of countries. In this context, particular focus is laid on the interrelation between asset prices and credit, as well as the potential importance of moral hazard and adverse selection. The second section complements this analysis by sketching the results of a number of more detailed studies of issues in financial fragility that have been made at a national level, and which are nonetheless considered to have a broader applicability. In the third section, four further periods of systemic risk, namely the banking crises in Finland, Sweden, and Japan, and the collapse of activity in the ECU bond market in 1992, are analysed in the light of the framework for analysis developed in Chs. 5 and 7. The degree to which they confirm the generality of the phenomena outlined earlier in the book is considered in a final part of this section.
George W. Evans and Seppo Honkapohja
- Published in print:
- 2013
- Published Online:
- October 2017
- ISBN:
- 9780691155234
- eISBN:
- 9781400846450
- Item type:
- chapter
- Publisher:
- Princeton University Press
- DOI:
- 10.23943/princeton/9780691155234.003.0003
- Subject:
- Economics and Finance, Macro- and Monetary Economics
This chapter examines the central ideas about learning and bounded rationality for macroeconomics and finance. It first introduces the main methodological issues concerning expectation formation and ...
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This chapter examines the central ideas about learning and bounded rationality for macroeconomics and finance. It first introduces the main methodological issues concerning expectation formation and learning before discussing the circumstances in which rational expectations may arise. It then reviews empirical work that applies learning to macroeconomic issues and asset prices, along with the implications of the use of structural knowledge in learning and the form of the agents' decision rules. As an application, the scope of Ricardian Equivalence is considered. The chapter also presents three applications of the learning approach to monetary policy: the appropriate specification of interest rate rules; implementation of price-level targeting to achieve learning stability of the optimal rational expectations equilibrium; and whether under learning, commitment to price-level targeting can be sufficient to rule out the deflation trap of a zero interest rate lower bound and return the economy to the intended rational expectations steady state.Less
This chapter examines the central ideas about learning and bounded rationality for macroeconomics and finance. It first introduces the main methodological issues concerning expectation formation and learning before discussing the circumstances in which rational expectations may arise. It then reviews empirical work that applies learning to macroeconomic issues and asset prices, along with the implications of the use of structural knowledge in learning and the form of the agents' decision rules. As an application, the scope of Ricardian Equivalence is considered. The chapter also presents three applications of the learning approach to monetary policy: the appropriate specification of interest rate rules; implementation of price-level targeting to achieve learning stability of the optimal rational expectations equilibrium; and whether under learning, commitment to price-level targeting can be sufficient to rule out the deflation trap of a zero interest rate lower bound and return the economy to the intended rational expectations steady state.
Ed Nosal and Guillaume Rocheteau
- Published in print:
- 2011
- Published Online:
- August 2013
- ISBN:
- 9780262016285
- eISBN:
- 9780262298285
- Item type:
- chapter
- Publisher:
- The MIT Press
- DOI:
- 10.7551/mitpress/9780262016285.003.0011
- Subject:
- Economics and Finance, Econometrics
This chapter investigates the process through which asset prices are determined in monetary economies. Here, fiat money is viewed as an asset when situated within a monetary economy. Though its ...
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This chapter investigates the process through which asset prices are determined in monetary economies. Here, fiat money is viewed as an asset when situated within a monetary economy. Though its fundamental value is zero, fiat money appears to have positive value if there is limited enforcement and a lack of record-keeping. The presents study focuses on an environment void of money, but with a fixed supply of assets. It shows that just like fiat money, real assets can be used as a medium of exchange in decentralized trades. Next, the chapter explores how inflation affects the pricing of assets within an environment that has a fixed supply of real assets. It also determines the possible value of assets by analyzing rate-of-return differences across assets as stemming from liquidity differences.Less
This chapter investigates the process through which asset prices are determined in monetary economies. Here, fiat money is viewed as an asset when situated within a monetary economy. Though its fundamental value is zero, fiat money appears to have positive value if there is limited enforcement and a lack of record-keeping. The presents study focuses on an environment void of money, but with a fixed supply of assets. It shows that just like fiat money, real assets can be used as a medium of exchange in decentralized trades. Next, the chapter explores how inflation affects the pricing of assets within an environment that has a fixed supply of real assets. It also determines the possible value of assets by analyzing rate-of-return differences across assets as stemming from liquidity differences.
