12 votes

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

The first metric to look at is house-price-to-rent ratios. Rental prices capture the value of the housing (and housing-linked) services provided by a property, including things like how safe a ...
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7 votes

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

While it is possible to rigorously define a bubble in principle (see for example asset markets where prices violate transversality conditions), in practice it can be difficult or impossible to ...
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6 votes
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Examples of Factors in the ICAPM

ICAPM Factors People have chosen different ways to pick factors. Chen, Roll and Ross are a classic example of attempts to find reasonable ICAPM factors. Fama-French factors are often explained as ...
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  • 2,006
6 votes

Log-linearization of Euler equation with an expectation term

Let's ignore for the moment the existence of the expected value. If this was a deterministic set-up, linearization through taking logs would be straightforward, and without the tricks of the links the ...
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6 votes
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The Insane Sultan of Slickcrudistan: Calculating Currency Equilibrium

Using a simple textbook-approach, I will provide one possible answer here, showing that in this approach, the one thing that needs to be specified is "velocity of money" as regards sand dollars. I ...
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6 votes
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Financial Economics Textbooks

The recommended books are decent. From these two I'd go with Bailey first and if you're comfortable with that, then LeRoy & Werner. The latter requires some background in linear algebra and ...
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  • 1,218
6 votes
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Example of Law of One Price holds but No Arbitrage Fails

Examples where this happens are always extreme and contrived. I can think of two kinds of examples. The first is where you have an asset that for some reason has a price of zero or negative but a ...
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  • 9,127
6 votes
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Are no arbitrage models and equilibrium models equivalent?

...no-arbitrage models (such as Black-Scholes and HJM) are equivalent to equilibrium models (such as CAPM or C-CAPM). Short Answer Yes, for models where asset prices are assumed to be Ito ...
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  • 2,559
5 votes
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Derivative of CARA utility

All you need for this particular question is the following. Let $\mathbf{X}$ be a $T \times K$ matrix, $\mathbf{w}$ a K-dimensional vector and $\mathbf{y}$ a T-dimensional vector, then $$ \begin{...
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5 votes

Log-linearization of Euler equation with an expectation term

Your problem seems like asset-pricing equation with recursive (Epstein-Zin) preferences. When interested in asset prices, one has to be careful with the usual "macroeconomic" linearization. Such an ...
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  • 1,036
5 votes

Log-linearization of Euler equation with an expectation term

The correct approximation is $f(x) \approx E[f(x)] + E[f'(x)] (x - E[x])$. This is unbiased, whereas $f(x) \approx E[f(x)] + f'(E[x]) (x - E[x])$ is not. To see this, project $f(x) - \overline{f(x)}$ ...
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5 votes

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

With apologies for the somewhat journalistic answer (as others have noted, even defining a bubble in a rigorous fashion is difficult). Information on housing supply may be of some use. Demand for ...
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5 votes
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Hedging with volatility swaps?

What are volatility swaps? Before the introduction of what is now volatility swaps, investors gained exposure to the market's volatility (yes, they already wanted to) through call and put options, ...
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5 votes
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Apply Ito's Lemma to exponential martingale

$\newcommand{\dd}{\, \mathrm{d}}$ If we apply Ito's lemma, then \begin{align*} \dd \xi_t &= -\xi_t \dd X_t + \frac 12 \xi_t (\dd X_t)^2\\ &= -\xi_t \left(\frac 12 \lambda_t^2 \dd t + \...
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5 votes

Are options a form of insurance?

No, the primary purpose of options is not to provide insurance against changes in the price of the underlying instrument: options don't have a primary purpose, they don't have an agenda, and they don'...
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5 votes
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Deriving and using the pricing equation

As regards the first question, the "$p_t=...$" expression is conceptually and qualitatively useful because, at the optimum, it relates price with consumption and expectations. Mathematically it is an ...
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5 votes
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Who invented these key notions in Finance?

Net Present Value (NPV) as a soft concept existed probably even in antiquity but it was formalized and made popular by Irving Fisher in his book the Rate of Interest. Internal rate of return is ...
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4 votes

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

It's actually quite easy. The key things to know are 1) that the majority of house purchases are made via mortgage lending, and that 2) an excess of bank lending over bank loan repayment causes money ...
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4 votes
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Put Call Parity

How about a hint rather than an exact answer? Put Call Parity concerns the relationship between the prices of European put and call options (with matched strike and expiration dates): $$ C - P = D(F-K)...
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4 votes
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Stock pricing with cross ownership

The way I would think of this is as follows. Let us write the value of the first company as $V_{A}$and the second as $V_{B}.$ Given your definition, let me know if you agree with the following ...
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4 votes
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Pricing a European call option while absence of arbitrage is violated

I believe there is not a unique price. Say, instead of buying the option you spent 0.5 on a half a unit of the asset $S^2_1$ This asset pays out $[0.4, 0.6, 0.8]$ which first order stochastically ...
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4 votes

Does an instant settlement system (such as blockchains) eliminate the possibility for short selling?

Imagine: I borrow 1 bitcoin from you and agree to pay you back $(1+r)$ bitcoin in a month. I immediately sell the bitcoin you lent me. One month from now, I buy $(1+r)$ bitcoin and pay you back. If ...
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4 votes

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

There are no major models that come to the conclusion that idiosyncratic risk can drive positive returns. The reason is that idiosyncratic risk is diversifiable. The models, however, do in fact ...
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4 votes

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

It seems to me that we might as well say that markets are complete. It seems to me to be somewhat inconsequential since this is a representative agent model and that market clearing requires that the ...
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  • 9,127
4 votes

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

As mentioned in the comments this comes down to stylistic choices, since as you correctly pointed out: $$u(c_t)+\beta E_t[u(c_{t+1})]=E_t[u(c_t)+\beta u(c_{t+1})]$$ However, in principle both ...
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3 votes
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What is the market value of an object over time?

The value of a tradeable good is equal to what the marginal buyer will pay for it. I will explain further, but first let me correct one misconception in your question. You state: Now, once you buy ...
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3 votes

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

In Keynes's Treatise on Money he argued that the phenomenon you describe, known as "normal backwardation", is due to the fact that certain commodities producers hedge their price risk (importantly, ...
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3 votes
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Is there a theory about investors' behaviour during bubbles?

The investor has erroneously overvalued the value of the stock/commodity. Here is a prominent paper that models irrational bubbles: This paper attempts to formalise herd behaviour or mutual ...
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3 votes

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

I'll direct you to wikipedia which has some pretty good information about it. One of the important things about speculative bubbles is that they are very difficult to identify before they burst. It ...
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