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Econometric Asset Pricing Modelling

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  • Henri Bertholon

    (Crest)

  • Alain Monfort

    (Crest)

  • Fulvio Pegoraro

    (Crest)

Abstract

The purpose of this paper is to propose a general econometric approach to asset pricing modelling based onthree 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 (R.N.) factor dynamics. Retaining anexponential-affine specification of the SDF, its modelling is equivalent to the specification of the factor loading vectorand 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 Risk-Neutral Constrained Direct Modelling andthe Back Modelling. In all the approaches we study the internal consistency constraints, implied by the absence ofarbitrage opportunity (AAO) assumption, and the identification problem. We also propose interpretations of thefactor loading vector in terms of market price of risk. The general modelling strategies are applied to two importantcases: security market models and term structure of interest rates models. In the context of security market models,we show the relevance of our methods for various kinds of specifications: switching regime models, stochastic volatilitymodels, Gaussian and Inverse Gaussian GARCH-type models (with or without regime-switching). In the interestrates modelling context, we consider several illustrations: VAR modelling, Switching VAR modelling and Wishartmodelling. We also propose, using a Gaussian VAR(1) approach, an example of joint modelling of geometric returns,dividends and short rate. In these contexts we stress the usefulness of the Risk-Neutral Constrained Direct Modellingapproach and of the Back Modelling approach, both allowing to conciliate a flexible historical dynamics and a CarR.N. dynamics leading to explicit or quasi explicit pricing formulas for various derivative products. Moreover, wehighlight the possibility to specify asset pricing models able to accommodate non-affine historical and R.N. factordynamics with tractable pricing formulas. In this respect we introduce the new notion of Extended Car process whichis particularly promising.

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Bibliographic Info

Paper provided by Centre de Recherche en Economie et Statistique in its series Working Papers with number 2007-18.

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Length: 45
Date of creation: 2007
Date of revision:
Handle: RePEc:crs:wpaper:2007-18

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References

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Citations

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Cited by:
  1. Jeroen V.K. Rombouts & Lars Stentoft, 2009. "Bayesian Option Pricing Using Mixed Normal Heteroskedasticity Models," CREATES Research Papers 2009-07, School of Economics and Management, University of Aarhus.
  2. Alain Monfort & Jean-Paul Renne, 2011. "Credit and Liquidity Risks in Euro-area Sovereign Yield Curves," Working Papers 2011-26, Centre de Recherche en Economie et Statistique.
  3. Alain Monfort & Jean-Paul Renne, 2013. "Default, Liquidity, and Crises: an Econometric Framework," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 11(2), pages 221-262, March.
  4. Matthias R. Fengler & Helmut Herwartz & Christian Werner, 2012. "A Dynamic Copula Approach to Recovering the Index Implied Volatility Skew," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 10(3), pages 457-493, June.
  5. Aleksandar Mijatovic & Paul Schneider, 2009. "Empirical asset pricing with nonlinear risk premia," Papers 0911.0928, arXiv.org.
  6. Monfort, A. & Pegoraro, F., 2012. "Asset Pricing with Second-Order Esscher Transforms," Working papers 397, Banque de France.
  7. 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.
  8. 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," Energy Policy, Elsevier, vol. 37(1), pages 15-28, January.
  9. Massimo Guidolin, 2011. "Markov Switching Models in Empirical Finance," Working Papers 415, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  10. 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.
  11. 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.

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