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Econometric Asset Pricing Modelling

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  • H. Bertholon
  • A. Monfort
  • F. Pegoraro

Abstract

The purpose of this paper is to propose a general econometric approach to no-arbitrage asset pricing modelling based on three main ingredients: (i) the historical discrete-time dynamics of the factor representing the information, (ii) the stochastic discount factor (SDF), and (iii) the discrete-time risk-neutral (RN) factor dynamics. Retaining an exponential-affine specification of the SDF, its modelling is equivalent to the specification of the risk-sensitivity vector and of the short rate, if the latter is neither exogenous nor a known function of the factor. In this general framework, we distinguish three modelling strategies: the direct modelling, the RN constrained direct modelling, and the back modelling. In all the approaches, we study the internal consistency conditions (ICCs), implied by the absence of arbitrage opportunity assumption, and the identification problem. The general modelling strategies are applied to two important domains: security market models and term structure of interest rates models. In these contexts, we stress the usefulness (and we suggest the use) of the RN constrained direct modelling and of the back modelling approaches, both allowing us to conciliate a flexible (non-Car) historical dynamics and a Car (compound autoregressive) RN dynamics leading to explicit or quasi-explicit pricing formulas for various derivative products. Moreover, we highlight the possibility to specify asset pricing models able to accommodate non-Car historical and non-Car RN factor dynamics with tractable pricing formulas. This result is based on the notion of (RN) extended Car process that we introduce in the paper, and which allows us to deal with sophisticated models such as Gaussian and inverse Gaussian GARCH-type models with regime-switching, or Wishart quadratic term structure models. Copyright The Author 2008. Published by Oxford University Press. All rights reserved. For permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.

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Bibliographic Info

Article provided by Society for Financial Econometrics in its journal Journal of Financial Econometrics.

Volume (Year): 6 (2008)
Issue (Month): 4 (Fall)
Pages: 407-458

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Handle: RePEc:oup:jfinec:v:6:y:2008:i:4:p:407-458

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References

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Citations

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Cited by:
  1. Corsi, Fulvio & Fusari, Nicola & La Vecchia, Davide, 2013. "Realizing smiles: Options pricing with realized volatility," Journal of Financial Economics, Elsevier, vol. 107(2), pages 284-304.
  2. Monfort, A. & Renne, J-P., 2011. "Credit and liquidity risks in euro area sovereign yield curves," Working papers 352, Banque de France.
  3. Chevallier, Julien & Ielpo, Florian & Mercier, Ludovic, 2009. "Risk aversion and institutional information disclosure on the European carbon market : a case-study of the 2006 compliance event," Economics Papers from University Paris Dauphine 123456789/4221, Paris Dauphine University.
  4. Badescu, Alex & Elliott, Robert J. & Siu, Tak Kuen, 2009. "Esscher transforms and consumption-based models," Insurance: Mathematics and Economics, Elsevier, vol. 45(3), pages 337-347, December.
  5. Aleksandar Mijatovic & Paul Schneider, 2009. "Empirical Asset Pricing with Nonlinear Risk Premia," Working Papers wp09-03, Warwick Business School, Finance Group.
  6. Renne, J-P., 2009. "Frequency-domain analysis of debt service in a macro-finance model for the euro area," Working papers 261, Banque de France.
  7. ROMBOUTS, Jeroen V.K. & STENTOFT, Lars, 2009. "Bayesian option pricing using mixed normal heteroskedasticity models," CORE Discussion Papers 2009013, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  8. Massimo Guidolin, 2011. "Markov Switching Models in Empirical Finance," Working Papers 415, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  9. Matthias Fengler & Helmut Herwartz & Christian Werner, 2010. "A dynamic copula approach to recovering the index implied volatility skew," University of St. Gallen Department of Economics working paper series 2010 1132, Department of Economics, University of St. Gallen, revised Nov 2011.
  10. Alain MONFORT & Fulvio PEGORARO, 2010. "Asset Pricing with Second-Order Esscher Transforms," Working Papers 2010-54, Centre de Recherche en Economie et Statistique.
  11. Monfort, A. & Renne, J-P., 2011. "Default, liquidity and crises: an econometric framework," Working papers 340, Banque de France.

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