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Security Pricing with Information-Sensitive Discounting

In: Recent Advances In Financial Engineering 2009

Author

Listed:
  • Andrea Macrina

    (Department of Mathematics, King's College London, London WC2R 2LS, United Kingdom and Institute of Economic Research, Kyoto University, Kyoto 606-8501, Japan)

  • Priyanka A. Parbhoo

    (School of Computational and Applied Mathematics, University of the Witwatersrand, Johannesburg, Private Bag-3, Wits 2050, South Africa)

Abstract

In this paper, incomplete-information models are developed for the pricing of securities in a stochastic interest rate setting. In particular, 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 interest rates depend, and information processes associated with market 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 a European-style call bond option 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.

Suggested Citation

  • Andrea Macrina & Priyanka A. Parbhoo, 2010. "Security Pricing with Information-Sensitive Discounting," World Scientific Book Chapters, in: Masaaki Kijima & Chiaki Hara & Keiichi Tanaka & Yukio Muromachi (ed.), Recent Advances In Financial Engineering 2009, chapter 6, pages 157-180, World Scientific Publishing Co. Pte. Ltd..
    • Handle: RePEc:wsi:wschap:9789814304078_0006
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    Citations

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    Cited by:

    1. Jirô 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 1-15.
    2. Hoyle, Edward & Hughston, Lane P. & Macrina, Andrea, 2011. "Lévy random bridges and the modelling of financial information," Stochastic Processes and their Applications, Elsevier, vol. 121(4), pages 856-884, April.

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