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Inference on Risk-Neutral Measures for Incomplete Markets

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  • Hiroaki Kaido
  • Halbert White

Abstract

This paper proposes an econometric framework to estimate market risk prices associated with risk-neutral measures Q under incomplete markets. We show that, under incomplete markets, the market price of risk is not point-identified but is instead identified as a bounded subset of an affine subspace. On the other hand, a structural assumption fully identifies diffusion coefficients for the data-generating probability measure P. We apply Kaido and White's (2008, Discussion Paper, University of California, San Diego) two-stage extension of Chernozhukov, Hong, and Tamer's (2007, Econometrica, 75(5), 1243--1284) partial identification framework to construct a set estimator and confidence regions for the identified set of market risk prices and to test hypotheses. We apply our results to study international risk sharing and risk premiums for market cap range indexes. Copyright The Author 2009. Published by Oxford University Press. All rights reserved. For permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.

Suggested Citation

  • Hiroaki Kaido & Halbert White, 2009. "Inference on Risk-Neutral Measures for Incomplete Markets," Journal of Financial Econometrics, Oxford University Press, vol. 7(3), pages 199-246, Summer.
    • Handle: RePEc:oup:jfinec:v:7:y:2009:i:3:p:199-246
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    File URL: http://hdl.handle.net/10.1093/jjfinec/nbp004
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    Cited by:

    1. Kaido, Hiroaki, 2016. "A dual approach to inference for partially identified econometric models," Journal of Econometrics, Elsevier, vol. 192(1), pages 269-290.
    2. AlShelahi, Abdullah & Wang, Jingxing & You, Mingdi & Byon, Eunshin & Saigal, Romesh, 2020. "Data-driven prediction for volatile processes based on real option theories," International Journal of Production Economics, Elsevier, vol. 226(C).
    3. Chris Kenyon & Andrew Green, 2013. "Regulatory-Compliant Derivatives Pricing is Not Risk-Neutral," Papers 1311.0118, arXiv.org, revised Aug 2014.
    4. Juan Carlos Escanciano & Lin Zhu, 2013. "Set inferences and sensitivity analysis in semiparametric conditionally identified models," CeMMAP working papers 55/13, Institute for Fiscal Studies.
    5. Giuseppe Grande & Ignazio Visco, 2010. "A public guarantee of a minimum return to defined contribution pension scheme members," Temi di discussione (Economic working papers) 762, Bank of Italy, Economic Research and International Relations Area.
    6. Kaido, Hiroaki & White, Halbert, 2014. "A two-stage procedure for partially identified models," Journal of Econometrics, Elsevier, vol. 182(1), pages 5-13.
    7. Juan Carlos Escanciano & Lin Zhu, 2013. "Set inferences and sensitivity analysis in semiparametric conditionally identified models," CeMMAP working papers CWP55/13, Centre for Microdata Methods and Practice, Institute for Fiscal Studies.

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