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Securities Pricing with Information-Sensitive Discounting

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Author Info

  • Andrea Macrina

    (King's College London and Institute of Economic Research, Kyoto University)

  • Priyanka A. Parbhoo

    ()
    (University of the Witwatersrand)

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    Abstract

    In this paper incomplete-information models are developed for the pricing of securities in a stochastic interest rate setting. In particu- lar we consider credit-risky assets that may include random recovery upon default. The market filtration is generated by a collection of information processes associated with economic factors, on which in- terest rates depend, and information processes associated with mar- ket factors used to model the cash flows of the securities. We use information-sensitive pricing kernels to give rise to stochastic interest rates. Semi-analytical expressions for the price of credit-risky bonds are derived, and a number of recovery models are constructed which take into account the perceived state of the economy at the time of default. The price of European-style call bond options is deduced, and it is shown how examples of hybrid securities, like inflation-linked credit-risky bonds, can be valued. Finally, a cumulative information process is employed to develop pricing kernels that respond to the amount of aggregate debt of an economy.

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    File URL: http://www.kier.kyoto-u.ac.jp/DP/DP695.pdf
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    Bibliographic Info

    Paper provided by Kyoto University, Institute of Economic Research in its series KIER Working Papers with number 695.

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    Length: 28pages
    Date of creation: Jan 2010
    Date of revision:
    Handle: RePEc:kyo:wpaper:695

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    Related research

    Keywords: Asset pricing; incomplete information; stochastic interest rates; credit risk; recovery models; credit-inflation hybrid securities; information-sensitive pricing kernels;

    This paper has been announced in the following NEP Reports:

    References

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    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    1. Jiro Akahori & Yuji Hishida & Josef Teichmann & Takahiro Tsuchiya, 2009. "A Heat Kernel Approach to Interest Rate Models," Papers 0910.5033, arXiv.org.
    2. Robert A. Jarrow, 2009. "Credit Risk Models," Annual Review of Financial Economics, Annual Reviews, vol. 1(1), pages 37-68, November.
    3. JirĂ´ Akahori & Andrea Macrina, 2012. "Heat Kernel Interest Rate Models With Time-Inhomogeneous Markov Processes," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 15(01), pages 1250007-1-1.
    4. Lane P. Hughston & Andrea Macrina, 2009. "Pricing Fixed-Income Securities in an Information-Based Framework," Papers 0911.1610, arXiv.org, revised Apr 2010.
    5. L. C. G. Rogers, 1997. "The Potential Approach to the Term Structure of Interest Rates and Foreign Exchange Rates," Mathematical Finance, Wiley Blackwell, vol. 7(2), pages 157-176.
    6. Hinnerich, Mia, 2008. "Inflation-indexed swaps and swaptions," Journal of Banking & Finance, Elsevier, vol. 32(11), pages 2293-2306, November.
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