Dynamic asset pricing with non-redundant forwards
We consider an incomplete but frictionless financial market in which non-redundant forward contracts contribute to span the uncertainty present in the economy. When such forward contracts are available for trade, some standard results of portfolio and dynamic asset pricing theory must be amended. When the investment opportunity set is driven by K state variables, a (K+4)-mutual fund separation theorem is obtained in lieu of Merton’s classic (K+2)-fund separation. The two additional funds are fully characterized. One fund is a portfolio containing forward contracts only, and the other fund is a portfolio of cash assets and forward contracts that hedges the interest rate risk brought about by the optimal portfolio strategy itself. The latter risk is due to the fact that, when a forward contract is involved, incurred profits or losses that accrue to the investor’s wealth at each instant are locked-in in the forward position up to the contract maturity. Thus discounting these gains or losses back at the current date gives rise to an interest rate risk. A second important result is that the mean-variance efficiency of the market portfolio of cash assets is neither a necessary nor a sufficient condition for the linear relationship between expected return and beta to hold. Finally, the pricing equation for a forward contract is shown to contain an extra term relative to that for a cash asset. We name this term a strategy risk premium. It compensates the investor for the (systematic) risk that stems from his very portfolio strategy
(This abstract was borrowed from another version of this item.)
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
References listed on IDEAS
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.:
- Cox, John C. & Ingersoll, Jonathan Jr. & Ross, Stephen A., 1981. "The relation between forward prices and futures prices," Journal of Financial Economics, Elsevier, vol. 9(4), pages 321-346, December.
- He, Hua & Pages, Henri F, 1993. "Labor Income, Borrowing Constraints, and Equilibrium Asset Prices," Economic Theory, Springer, vol. 3(4), pages 663-96, October.
- Basak, Suleyman, 1999.
"On the fluctuations in consumption and market returns in the presence of labor and human capital: An equilibrium analysis,"
Journal of Economic Dynamics and Control,
Elsevier, vol. 23(7), pages 1029-1064, June.
- Süleyman Basak, . "On the Fluctuations in Consumption and Market Returns in the Presence of Labor and Human Capital: An Equilibrium Analysis," Rodney L. White Center for Financial Research Working Papers 10-98, Wharton School Rodney L. White Center for Financial Research.
- Breeden, Douglas T., 1984. "Futures markets and commodity options: Hedging and optimality in incomplete markets," Journal of Economic Theory, Elsevier, vol. 32(2), pages 275-300, April.
- Merton, Robert C., 1971.
"Optimum consumption and portfolio rules in a continuous-time model,"
Journal of Economic Theory,
Elsevier, vol. 3(4), pages 373-413, December.
- R. C. Merton, 1970. "Optimum Consumption and Portfolio Rules in a Continuous-time Model," Working papers 58, Massachusetts Institute of Technology (MIT), Department of Economics.
- Ohashi, Kazuhiko, 1997. "Optimal Futures Innovation in a Dynamic Economy: The Discrete-Time Case," Journal of Economic Theory, Elsevier, vol. 74(2), pages 448-465, June.
- Rubinstein, Mark, 1976. "The Strong Case for the Generalized Logarithmic Utility Model as the Premier Model of Financial Markets," Journal of Finance, American Finance Association, vol. 31(2), pages 551-71, May.
- Brian R. Horrigan, 1987. "The CPI futures market: the inflation hedge that won't grow," Business Review, Federal Reserve Bank of Philadelphia, issue May, pages 3-14.
- Sumner, Scott, 1995. "The Impact of Futures Price Targeting on the Precision and Credibility of Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(1), pages 89-106, February.
- Cowen, Tyler, 1997. "Should Central Banks Target CPI Futures?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(3), pages 275-85, August.
- Ohashi Kazuhiko, 1995. "Endogenous Determination of the Degree of Market-Incompleteness in Futures Innovation," Journal of Economic Theory, Elsevier, vol. 65(1), pages 198-217, February.
- Sumner, Scott, 1997. "Can Monetary Stabilization Policy Be Improved by CPI Futures Targeting? Reply," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(4), pages 542-45, November.
- Stefano Athanasoulis & Robert J. Shiller & Eric Van Wincoop, 1999. "Macro markets and financial security," Economic Policy Review, Federal Reserve Bank of New York, issue Apr, pages 21-39.
- Dowd, Kevin, 1994. "A Proposal to End Inflation," Economic Journal, Royal Economic Society, vol. 104(425), pages 828-40, July.
- Breeden, Douglas T., 1979. "An intertemporal asset pricing model with stochastic consumption and investment opportunities," Journal of Financial Economics, Elsevier, vol. 7(3), pages 265-296, September.
- Fama, Eugene F., 1996. "Multifactor Portfolio Efficiency and Multifactor Asset Pricing," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 31(04), pages 441-465, December.
- Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-87, September.
- Abraham Lioui & Patrice Poncet, 2000. "The Minimum Variance Hedge Ratio Under Stochastic Interest Rates," Management Science, INFORMS, vol. 46(5), pages 658-668, May.
- Harrison, J. Michael & Kreps, David M., 1979. "Martingales and arbitrage in multiperiod securities markets," Journal of Economic Theory, Elsevier, vol. 20(3), pages 381-408, June.
- Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "An Intertemporal General Equilibrium Model of Asset Prices," Econometrica, Econometric Society, vol. 53(2), pages 363-84, March.
- Richard, Scott F. & Sundaresan, M., 1981. "A continuous time equilibrium model of forward prices and futures prices in a multigood economy," Journal of Financial Economics, Elsevier, vol. 9(4), pages 347-371, December.
When requesting a correction, please mention this item's handle: RePEc:eee:dyncon:v:27:y:2003:i:7:p:1163-1180. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.