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Inference on Risk-Neutral Measures for Incomplete Markets

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  • Hiroaki Kaido
  • Halbert White

Abstract

This paper proposes an econometric framework to estimate market risk prices associated with risk-neutral measures Q under incomplete markets. We show that, under incomplete markets, the market price of risk is not point-identified but is instead identified as a bounded subset of an affine subspace. On the other hand, a structural assumption fully identifies diffusion coefficients for the data-generating probability measure P. We apply Kaido and White's (2008, Discussion Paper, University of California, San Diego) two-stage extension of Chernozhukov, Hong, and Tamer's (2007, Econometrica, 75(5), 1243--1284) partial identification framework to construct a set estimator and confidence regions for the identified set of market risk prices and to test hypotheses. We apply our results to study international risk sharing and risk premiums for market cap range indexes. Copyright The Author 2009. Published by Oxford University Press. All rights reserved. For permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.

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File URL: http://hdl.handle.net/10.1093/jjfinec/nbp004
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Bibliographic Info

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

Volume (Year): 7 (2009)
Issue (Month): 3 (Summer)
Pages: 199-246

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Handle: RePEc:oup:jfinec:v:7:y:2009:i:3:p:199-246

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Cited by:
  1. Chris Kenyon & Andrew Green, 2013. "Regulatory-Compliant Derivatives Pricing is Not Risk-Neutral," Papers 1311.0118, arXiv.org.
  2. Juan Carlos Escanciano & Lin Zhu, 2013. "Set inferences and sensitivity analysis in semiparametric conditionally identified models," CeMMAP working papers CWP55/13, Centre for Microdata Methods and Practice, Institute for Fiscal Studies.

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