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A Note on Contingent Claims Pricing with Non-Traded Assets

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Author Info

  • Ericsson, Jan

    ()
    (McGill University)

  • Reneby, Joel

    ()
    (Dept. of Finance, Stockholm School of Economics)

Abstract

One of the main objections to applying contingent claims analysis outside the area of derivatives pricing, such as to the pricing of corporate (or sovereign) debt, has been that it is not possible to trade in the relevant state variable, e.g. the assets of a firm. Consequently, replicating portfolios can not be formed and preference free pricing does not result. The aim of this paper is to show that assuming traded assets, as is routinely done, is inconsistent with the presence of stocks and bonds. It is also unnecessary. We argue that a superior alternative to obtain a complete markets setting, is to assume that at least one of the firm's securities, e.g. equity, is traded.

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File URL: http://swopec.hhs.se/hastef/papers/hastef0314.pdf
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Bibliographic Info

Paper provided by Stockholm School of Economics in its series Working Paper Series in Economics and Finance with number 314.

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Length: 8 pages
Date of creation: 29 Mar 1999
Date of revision: 01 Feb 2002
Handle: RePEc:hhs:hastef:0314

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Related research

Keywords: corporate bonds; real options; contingent claims; traded assets; underlying assets.;

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References

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  1. Anderson, Ronald W & Sundaresan, Suresh, 1996. "Design and Valuation of Debt Contracts," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 9(1), pages 37-68.
  2. Hayne E. Leland and Klaus Bjerre Toft., 1995. "Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads," Research Program in Finance Working Papers, University of California at Berkeley RPF-259, University of California at Berkeley.
  3. Longstaff, Francis A & Schwartz, Eduardo S, 1995. " A Simple Approach to Valuing Risky Fixed and Floating Rate Debt," Journal of Finance, American Finance Association, American Finance Association, vol. 50(3), pages 789-819, July.
  4. Jarrow, Robert A & Lando, David & Turnbull, Stuart M, 1997. "A Markov Model for the Term Structure of Credit Risk Spreads," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 10(2), pages 481-523.
  5. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers, Massachusetts Institute of Technology (MIT), Sloan School of Management 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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Cited by:
  1. Simon Gilchrist & Vladimir Yankov & Egon Zakrajsek, 2009. "Credit Market Shocks and Economic Fluctuations: Evidence from Corporate Bond and Stock Markets," NBER Working Papers 14863, National Bureau of Economic Research, Inc.
  2. (Kim | Lopez-Salido | Swanson) & Andrew Levin, 2004. "The magnitude and Cyclical Behavior of Financial Market Frictions," Computing in Economics and Finance 2004, Society for Computational Economics 224, Society for Computational Economics.
  3. Jawwad Noor, 2007. "Hyperbolic Discounting and the Standard Model," Boston University - Department of Economics - Working Papers Series, Boston University - Department of Economics WP2007-028, Boston University - Department of Economics.
  4. Ericsson, Jan & Reneby, Joel, 2003. "Valuing Corporate Liabilities," SIFR Research Report Series, Institute for Financial Research 15, Institute for Financial Research.
  5. Reneby, Joel & Ericsson, Jan, 2001. "The Valuation of Corporate Liabilities: Theory and Tests," Working Paper Series in Economics and Finance, Stockholm School of Economics 445, Stockholm School of Economics, revised 19 Dec 2002.

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