Questions tagged [asset-pricing]

The branch of Finance that studies and models how specific assets (such as options, bonds and stocks) are priced.

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Log-linearization of Euler equation with an expectation term

There are a few online resources available to help with log-linearization (e.g., here or here). However, log-linearization where an expectation is involved is a little tricky because the log can't ...
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11 votes
6 answers
819 views

What metrics would indicate a house bubble rather than genuine market values?

There are concerns that Auckland, New Zealand, is currently experiencing a housing bubble. Auckland is one of the top 10 cities in the world on a housing unaffordability index. The question is - ...
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10 votes
5 answers
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Are options a form of insurance?

In my economics classes we have studied some really rudimentary concepts about insurance. I'm not really sure what qualifies as insurance to be honest. I was wondering if options are considered a ...
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9 votes
2 answers
869 views

Examples of Factors in the ICAPM

The intertemporal capital asset pricing model (ICAPM) is different from the CAPM in that in the ICAPM, utility is conditioned on some set of state variables. The ICAPM results in a multifactor pricing ...
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8 votes
3 answers
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What are some theoretical explanations for deviations from the efficient market hypothesis?

According (the semi-strong form of) the efficient market hypothesis, the price of an asset should reflect all publicly available information about the 'fundamental value' of that asset. The reasoning ...
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8 votes
2 answers
968 views

How is momentum justified as a common risk factor?

Momentum as a common risk factor? This question is partly a follow-up to another question found here. In this other question it was noted in momentum is difficult to explain as a common risk factor ...
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8 votes
1 answer
203 views

Hedging with volatility swaps?

I'm studying financial derivatives, and became curiosity in volatility products, more specifically volatility swaps. It always intrigued me how can you create products based on volatility. Who is ...
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8 votes
2 answers
580 views

Log-normality assumption in consumption based asset pricing

Consider a very basic discrete time representative consumer maximization problem with CRRA utility. There exist a risky asset with time $t$ price $p_t$ that pays time $t+1$ dividend $d_{t+1}$ , and a ...
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7 votes
1 answer
190 views

Are no arbitrage models and equilibrium models equivalent?

This YouTube video from WHU (starting from 3:50) claims that no-arbitrage models (such as Black-Scholes and HJM) are equivalent to equilibrium models (such as CAPM or C-CAPM). He uses the Euler ...
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7 votes
1 answer
214 views

Pricing a European call option while absence of arbitrage is violated

Assume that we have a general one-period market model consisting of d+1 assets and N states. Using a replicating portfolio $\phi$, determine $\Pi(0;X)$, the price of a European call option, with ...
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  • 388
7 votes
1 answer
240 views

Stock pricing with cross ownership

Cross-ownership is a phenomenon where companies own parts of other companies they do business with. An example: Two companies are now involved in the diamond operation, the mining group Anglo-...
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6 votes
2 answers
2k views

Financial Economics Textbooks

I have an interest in financial economics, and I plan to take the graduate sequence, however I did not take an undergraduate course in that field. I would really appreciate it if someone could ...
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6 votes
2 answers
364 views

Does the Lucas (1978) asset pricing model feature complete markets?

The Lucas (1978) asset pricing model seems to be one of the workhorse models in finance / asset pricing models. It also seems to be the case that the environment, with claims to $n$ (exogenous) ...
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6 votes
1 answer
278 views

Deriving and using the pricing equation

I'm a mathematician who's trying to learn some economics from Cochrane's Asset Pricing book. I don't have any background in economics. In chapter 1, he derives the basic pricing equation $$ p_t = \...
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6 votes
1 answer
164 views

Is it correct to say that wealth is "destroyed" when an asset bubble bursts?

I was reading this article from the World Economic Forum, when I came across this passage: When the global equity and real estate markets hit their lowest points in March 2009, \$34.4 trillion of ...
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6 votes
1 answer
2k views

Apply Ito's Lemma to exponential martingale

$\newcommand{\dd}{\, \mathrm{d}}$ Consider the exponential martingale, $$ \xi_t^\lambda = \exp \left\{ - \int_0^t \lambda_s \dd z_s - \frac 12 \int_0^T \lambda_s^2 \dd s \right\}, $$ that is used in ...
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6 votes
2 answers
110 views

Any major theory/model that considers return due to idiosyncratic risk?

Are there any classical, major theories/models that consider positive return due to idiosyncratic risk? For example, CAPM only considers return due to systemic risk but not idiosyncratic risk. If ...
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6 votes
1 answer
107 views

Uncovered interest parity and asymmetric capital controls

To derive the uncovered interest parity (UIP) condition we assume, among other things, that there is free movement of capital across countries. But this cannot be directly applied to India because of ...
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6 votes
1 answer
119 views

Pricing a negative externality under high uncertainty and severe non-linearity

Take a negative externality such as excess greenhouse gas emissions. We know some awkward things about the economic cost of this externality: There is fairly large uncertainty about the timing of ...
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6 votes
1 answer
78 views

Is over-valuation of a start up genuinely detrimental to the start up's future?

I recently watched S02E01 of Silicon Valley. In it, having demonstrated a breakthrough algorithm, the guys are pursued by investors with increasing funding offers. However, the founder is warned ...
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5 votes
1 answer
1k views

Example of Law of One Price holds but No Arbitrage Fails

I have been told that no arbitrage is a stronger assumption than than the law of one price. In particular, Law of One Price is equivalent to the existence of a stochastic discount factor, whereas no ...
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5 votes
1 answer
262 views

The Insane Sultan of Slickcrudistan: Calculating Currency Equilibrium

I work for a start-up that has encountered an economics problem no one on our team has been able to crack. A story form and a general form of the problem are below. I believe they are equivalent, but ...
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5 votes
2 answers
158 views

Find probability that payoff function is in $[10,20]$

In moment $t=0$ we bought option with expiration date $T=2$. The payoff function of this option is given by: $$f=(\max_{t\in[0,T]} S_t -110)^{+}$$ where $S_t$ satisfies $$dS_t=15dW_t$$ $$S_0=95$$ ...
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5 votes
1 answer
186 views

Is there a theory about investors' behaviour during bubbles?

As far as I can see there are two senses in which it's 'rational' for an investor to buy during a bubble. The investor has erroneously overvalued the value of the stock/commodity. The investor is ...
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5 votes
1 answer
105 views

Finding a maximal growth portfolio

I have the following problem that asks me to solve for the "maximal growth portfolio." Suppose that the equilibrium stochastic discount factor evolves as $$ \log S_{t+1} - \log S_t = \kappa_s(X_t,...
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5 votes
1 answer
194 views

What exactly is/How exactly do we interpret the binomial model's Radon-Nikodym derivative?

Related: Lewis' triviality result? As I recall the one-step binomial model goes like this: The time periods are now $t=0$ and later $t=1$. We have 2.1. a stock that pays off $u$ for going up or $d$...
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5 votes
1 answer
70 views

Markets that are linked to options prices

I recently went through a serious of lectures on economics and markets, and I was surprised by the lectures on options. The lecturer, said that the future prices of certain commodities like rice (food)...
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5 votes
1 answer
79 views

Do assets without rental income streams appreciate relative to assets with rental income streams?

In his book "The Armchair Economist", economist Steve Landsburg critiques an op-ed concerning the relative value of stocks and real estate: James K. Glassman wrote a piece in The New Republic to ...
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4 votes
1 answer
110 views

Why utility rather than expected utility in Cochrane's "Asset Pricing"?

Cochrane "Asset Pricing" Chapter 1 p. 6 says We model investors by a utility function defined over current and future values of consumption, $$ U(c_t,c_{t+1}) = u(c_t) + \beta \mathbb{E_t}[...
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4 votes
2 answers
90 views

Do the number of days in a month affect monthly return? (seasonality)

When I see data like monthly return on news or tv, I always find the concept a bit strange, because obviously if you calculate monthly return for February and March, all things being equal, the ...
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4 votes
1 answer
114 views

Nonseparable utility across states of nature: an intuitive example

I am new to nonseparable utility across states of nature as found in some macro-financial models (discussed in this YouTube video lecture by John Cochrane). I do not find the notion intuitive. Could ...
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4 votes
1 answer
136 views

Why is the term structure curve of agricultural commodities often downward sloping?

I have retrieved the below term structure curve for livestock (lean hogs) from Bloomberg and noticed that it is inverted. I have a vague intuition that this has to do with the storage costs and ...
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4 votes
1 answer
1k views

Proving there exists no arbitrage opportunities given 3 states and 2 assets

Assume there are 3 states of the world: w1, w2, and w3. Assume there are two assets: a risk-free asset returning Rf in each state, and a risky asset with Return R1 in state w1, R2 in state w2, and R3 ...
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4 votes
1 answer
359 views

Arbitrage Pricing Theory (APT), orthogonal factors

Why in the Arbitrage Pricing Theory (APT), one of the assumptions is that the factors has to be orthonogal? what if not?
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4 votes
1 answer
98 views

Effectiveness of recycling (consumer PET) plastic

Is recycling plastic, all things considered, efficient as compared to disposing of them and making new plastic? I'm looking in efficiency rates in free market environment and also full process of ...
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4 votes
3 answers
4k views

Why are asset pricing models equilibrium models?

I have several times heard scholars refer to asset pricing models (such as the CAPM) as a type of equilibrium model. Why exactly is this the case? Does this simply mean that equilibrium is a necessary ...
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4 votes
1 answer
1k views

Portfolio choice problem of a CARA investor with n risky assets

Ok, I am working on a problem that consists of the following: I am looking to solve the portfolio choice optimization problem (maximizing utility with a known utility function) in the case where all ...
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4 votes
1 answer
568 views

What is the difference between conditional and unconditional risk premia?

This is an asset pricing question. What is the difference between conditional and unconditional risk premia? Here's the context: The fact that carry trade strategies typically earn positive average ...
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3 votes
3 answers
150 views

Why do housing and parking cost more in urban than in rural areas, but road access doesn't?

In city centres, land is more expensive than in suburban or rural areas, as land is scarce. Consequentially, housing and parking in cities cost more. However, the same is not true for using the road ...
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3 votes
2 answers
284 views

Difference between objective and subjective distributions in asset pricing models?

How does one differentiate between "objective" and "subjective" probability distributions in asset pricing models? In asset pricing, economists often make a distinction between the "subjective" and ...
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3 votes
1 answer
322 views

Who invented these key notions in Finance?

We often give credit to the origins of academic achievements. The Black-Scholes equation or the Gibbons Ross Shanken (GRS) test etc. What about Net Present Value (NPV), Internal Rate of Return (IRR),...
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3 votes
1 answer
109 views

Does easy credit in a region cause property to be more expensive?

Does easy credit (e.g. lower minimum down payment, lower interest rate) cause housing prices (purchase, rent) in that area to be more expensive? Intuitively, this seems to be the case, because the ...
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3 votes
2 answers
274 views

What are the economic justifications of the size premium?

What are the economic justifications of the size premium? In factor pricing models like the intertemportal capital asset pricing model (I-CAPM) or arbitrage pricing theory (APT), it is assumed that ...
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  • 9,127
3 votes
1 answer
339 views

Calculating present value using Euler's number

So I was reading here where they calculate the expected value of an option at present given the expected value of the option in a year by calculating $$C_0 = C_1 e^{(-r)}$$ where r is the interest ...
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  • 133
3 votes
1 answer
183 views

Optimal pricing for Crypto-Currency Exchanges

I have a general understanding of game theory, and want to try to apply it to crypto-currency exchanges, which are completely decentralised systems. I come from a finance background so I will define ...
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3 votes
1 answer
3k views

Under what condition would the law of one price hold?

Under the consumption-based model for asset pricing, different people will have different prices because of their different utility functions. What is the force that make the law of one price hold? ...
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3 votes
1 answer
141 views

Assets, Liabilities, Equity [closed]

I am writing a business plan based on some old notes from a master in economics. However I am I bit confused. Can you please confirm the following is right? (above all what's marked in bold) Assets: ...
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  • 133
3 votes
1 answer
178 views

What is the market value of an object over time?

Recently many news articles mentioned the new luxury car Maybach Exelero. Only 2 cars have been manufactured. Moreover, one of the cars has been sold for 8 million dollars, which makes this car one of ...
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  • 133
3 votes
1 answer
141 views

Show that the dividend price ratio is a ARMA(p, q) process

Let the log dividend growth evolve according to $\Delta d_{t+1} = \epsilon_{d, t+1}$ where $\epsilon_{d, t+1}$ is just white noise. Let the log returns be $r_{t+1} = x_t + y_t + \epsilon_{r, t+1}$ ...
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