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A class of asset pricing models governed by subordinate processes that signal economic shocks

  • Jagannathan, Raj
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    We consider a mean-reverting risk-neutral short rate process model with a vector of subordinated drift processes that accounts for the random effect of the arrival of new information. It is assumed that the market is efficient with no arbitrage opportunities. Closed form expressions for the price in nominal and in real terms of a discount bond are obtained. We define a risk-neutral exchange rate model with correlated subordinated drift and volatility processes that reflect the effect of the arrival of new information pertaining to the countries involved. The cases of complete and incomplete exchange markets with no arbitrage opportunities are considered.

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    Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

    Volume (Year): 32 (2008)
    Issue (Month): 12 (December)
    Pages: 3820-3846

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    Handle: RePEc:eee:dyncon:v:32:y:2008:i:12:p:3820-3846
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    1. Michael J. Brennan & Yihong Xia, 2006. "International Capital Markets and Foreign Exchange Risk," Review of Financial Studies, Society for Financial Studies, vol. 19(3), pages 753-795.
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    4. Harris, Lawrence, 1987. "Transaction Data Tests of the Mixture of Distributions Hypothesis," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(02), pages 127-141, June.
    5. Darrell Duffie & Rui Kan, 1996. "A Yield-Factor Model Of Interest Rates," Mathematical Finance, Wiley Blackwell, vol. 6(4), pages 379-406.
    6. Clark, Peter K, 1973. "A Subordinated Stochastic Process Model with Finite Variance for Speculative Prices," Econometrica, Econometric Society, vol. 41(1), pages 135-55, January.
    7. Conley, Timothy G, et al, 1997. "Short-Term Interest Rates as Subordinated Diffusions," Review of Financial Studies, Society for Financial Studies, vol. 10(3), pages 525-77.
    8. David K. Backus, 2001. "Affine Term Structure Models and the Forward Premium Anomaly," Journal of Finance, American Finance Association, vol. 56(1), pages 279-304, 02.
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