IDEAS home Printed from https://ideas.repec.org/p/ihs/ihsesp/153.html
   My bibliography  Save this paper

General Properties of Rational Stock-Market Fluctuations

Author

Listed:
  • Mele, Antonio

    (The London School of Economics and Political Science)

Abstract

Which pricing kernel restrictions are needed to make low dimensional Markov models consistent with given sets of predictions on aggregate stock-market fluctuations? This paper develops theoretical test conditions addressing this and related reverse engineering issues arising within a fairly general class of long-lived asset pricing models. These conditions solely affect the first primitives of the economy (probabilistic descriptions of the world, information structures, and preferences). They thus remove some of the arbitrariness related to the specification of theoretical models involving unobserved variables, state-dependent preferences, and incomplete markets.

Suggested Citation

  • Mele, Antonio, 2004. "General Properties of Rational Stock-Market Fluctuations," Economics Series 153, Institute for Advanced Studies.
  • Handle: RePEc:ihs:ihsesp:153
    as

    Download full text from publisher

    File URL: http://www.ihs.ac.at/publications/eco/es-153.pdf
    File Function: First version, 2004
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Pietro Veronesi, 2000. "How Does Information Quality Affect Stock Returns?," Journal of Finance, American Finance Association, vol. 55(2), pages 807-837, April.
    2. Barsky, Robert B. & Long, J. Bradford De, 1990. "Bull and Bear Markets in the Twentieth Century," The Journal of Economic History, Cambridge University Press, vol. 50(2), pages 265-281, June.
    3. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
    4. Cecchetti, Stephen G. & Lam, Pok-sang & Mark, Nelson C., 1993. "The equity premium and the risk-free rate : Matching the moments," Journal of Monetary Economics, Elsevier, vol. 31(1), pages 21-45, February.
    5. Basak, Suleyman & Cuoco, Domenico, 1998. "An Equilibrium Model with Restricted Stock Market Participation," Review of Financial Studies, Society for Financial Studies, vol. 11(2), pages 309-341.
    6. Andrew B. Abel, 1991. "The equity premium puzzle," Business Review, Federal Reserve Bank of Philadelphia, issue Sep, pages 3-14.
    7. Yeung Lewis Chan & Leonid Kogan, 2002. "Catching Up with the Joneses: Heterogeneous Preferences and the Dynamics of Asset Prices," Journal of Political Economy, University of Chicago Press, vol. 110(6), pages 1255-1285, December.
    8. Isabelle Bajeux‐Besnainou & Jean‐Charles Rochet, 1996. "Dynamic Spanning: Are Options An Appropriate Instrument?1," Mathematical Finance, Wiley Blackwell, vol. 6(1), pages 1-16, January.
    9. Bergman, Yaacov Z & Grundy, Bruce D & Wiener, Zvi, 1996. "General Properties of Option Prices," Journal of Finance, American Finance Association, vol. 51(5), pages 1573-1610, December.
    10. Nicole El Karoui & Monique Jeanblanc‐Picquè & Steven E. Shreve, 1998. "Robustness of the Black and Scholes Formula," Mathematical Finance, Wiley Blackwell, vol. 8(2), pages 93-126, April.
    11. Lior Menzly & Tano Santos & Pietro Veronesi, 2004. "Understanding Predictability," Journal of Political Economy, University of Chicago Press, vol. 112(1), pages 1-47, February.
    12. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
    13. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-1445, November.
    14. Abel, Andrew B, 1994. "Exact Solutions for Expected Rates of Return under Markov Regime Switching: Implications for the Equity Premium Puzzle," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 26(3), pages 345-361, August.
    15. Masaaki Kijima, 2002. "Monotonicity And Convexity Of Option Prices Revisited," Mathematical Finance, Wiley Blackwell, vol. 12(4), pages 411-425, October.
    16. Abel, Andrew B., 1988. "Stock prices under time-varying dividend risk : An exact solution in an infinite-horizon general equilibrium model," Journal of Monetary Economics, Elsevier, vol. 22(3), pages 375-393.
    17. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April.
    18. Leonid Kogan & Raman Uppal, "undated". "Risk Aversion and Optimal Portfolio Policies in Partial and General Equilibrium Economies," Rodney L. White Center for Financial Research Working Papers 13-00, Wharton School Rodney L. White Center for Financial Research.
    19. Gennotte, Gerard, 1986. "Optimal Portfolio Choice under Incomplete Information," Journal of Finance, American Finance Association, vol. 41(3), pages 733-746, July.
    20. Campbell, John Y., 1999. "Asset prices, consumption, and the business cycle," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 19, pages 1231-1303, Elsevier.
    21. Malkiel, Burton G, 1979. "The Capital Formation Problem in the United States," Journal of Finance, American Finance Association, vol. 34(2), pages 291-306, May.
    22. Marc Romano & Nizar Touzi, 1997. "Contingent Claims and Market Completeness in a Stochastic Volatility Model," Mathematical Finance, Wiley Blackwell, vol. 7(4), pages 399-412, October.
    23. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    24. John Y. Campbell, Robert J. Shiller, 1988. "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors," Review of Financial Studies, Society for Financial Studies, vol. 1(3), pages 195-228.
    25. David, Alexander, 1997. "Fluctuating Confidence in Stock Markets: Implications for Returns and Volatility," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 32(4), pages 427-462, December.
    26. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, vol. 2(3), pages 225-243, September.
    27. Antonio Mele, 2003. "Fundamental Properties of Bond Prices in Models of the Short-Term Rate," Review of Financial Studies, Society for Financial Studies, vol. 16(3), pages 679-716, July.
    28. Brennan, Michael & Wang, Ashley W & Xia, Yihong, 2003. "Estimation and Test of a Simple Model of Intertemporal Capital Asset Pricing," University of California at Los Angeles, Anderson Graduate School of Management qt20r0j5t8, Anderson Graduate School of Management, UCLA.
    29. Brennan, Michael J. & Xia, Yihong, 2001. "Stock price volatility and equity premium," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 249-283, April.
    30. He, Hua & Leland, Hayne, 1993. "On Equilibrium Asset Price Processes," Review of Financial Studies, Society for Financial Studies, vol. 6(3), pages 593-617.
    31. Jiang Wang, 1993. "A Model of Intertemporal Asset Prices Under Asymmetric Information," Review of Economic Studies, Oxford University Press, vol. 60(2), pages 249-282.
    32. Robert B. Barsky & J. Bradford De Long, 1993. "Why Does the Stock Market Fluctuate?," The Quarterly Journal of Economics, Oxford University Press, vol. 108(2), pages 291-311.
    33. Robert Goldstein & Fernando Zapatero, 1996. "General Equilibrium With Constant Relative Risk Aversion And Vasicek Interest Rates1," Mathematical Finance, Wiley Blackwell, vol. 6(3), pages 331-340, July.
    34. Jagannathan, Ravi, 1984. "Call options and the risk of underlying securities," Journal of Financial Economics, Elsevier, vol. 13(3), pages 425-434, September.
    35. Schwert, G William, 1989. " Why Does Stock Market Volatility Change over Time?," Journal of Finance, American Finance Association, vol. 44(5), pages 1115-1153, December.
    36. Alan L. Lewis, 2000. "Option Valuation under Stochastic Volatility," Option Valuation under Stochastic Volatility, Finance Press, number ovsv, April.
    37. Detemple, Jerome B, 1986. "Asset Pricing in a Production Economy with Incomplete Information," Journal of Finance, American Finance Association, vol. 41(2), pages 383-391, June.
    38. Abel, Andrew B., 1999. "Risk premia and term premia in general equilibrium," Journal of Monetary Economics, Elsevier, vol. 43(1), pages 3-33, February.
    39. Veronesi, Pietro, 1999. "Stock Market Overreaction to Bad News in Good Times: A Rational Expectations Equilibrium Model," Review of Financial Studies, Society for Financial Studies, vol. 12(5), pages 975-1007.
    40. Yaacov Z. Bergman & Bruce D. Grundy & Zvi Wiener, "undated". "General Properties of Option Prices (Revision of 11-95) (Reprint 058)," Rodney L. White Center for Financial Research Working Papers 1-96, Wharton School Rodney L. White Center for Financial Research.
    41. Ahn, Dong-Hyun & Gao, Bin, 1999. "A Parametric Nonlinear Model of Term Structure Dynamics," Review of Financial Studies, Society for Financial Studies, vol. 12(4), pages 721-762.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Hong Yan, 2009. "Estimation Uncertainty and the Equity Premium," International Review of Finance, International Review of Finance Ltd., vol. 9(3), pages 243-268, September.
    2. Antonio Mele, 2003. "Fundamental Properties of Bond Prices in Models of the Short-Term Rate," Review of Financial Studies, Society for Financial Studies, vol. 16(3), pages 679-716, July.
    3. Calvet, Laurent E. & Fisher, Adlai J., 2007. "Multifrequency news and stock returns," Journal of Financial Economics, Elsevier, vol. 86(1), pages 178-212, October.
    4. Nengjiu Ju & Jianjun Miao, 2012. "Ambiguity, Learning, and Asset Returns," Econometrica, Econometric Society, vol. 80(2), pages 559-591, March.
    5. Daniel Andrei & Bruce Carlin & Michael Hasler, 2019. "Asset Pricing with Disagreement and Uncertainty About the Length of Business Cycles," Management Science, INFORMS, vol. 67(6), pages 2900-2923, June.
    6. Suresh M. Sundaresan, 2000. "Continuous‐Time Methods in Finance: A Review and an Assessment," Journal of Finance, American Finance Association, vol. 55(4), pages 1569-1622, August.
    7. Yeung Lewis Chan & Leonid Kogan, 2002. "Catching Up with the Joneses: Heterogeneous Preferences and the Dynamics of Asset Prices," Journal of Political Economy, University of Chicago Press, vol. 110(6), pages 1255-1285, December.
    8. Campbell, John Y., 2003. "Consumption-based asset pricing," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 13, pages 803-887, Elsevier.
    9. Guidolin, Massimo & Timmermann, Allan, 2007. "Properties of equilibrium asset prices under alternative learning schemes," Journal of Economic Dynamics and Control, Elsevier, vol. 31(1), pages 161-217, January.
    10. Massimo Guidolin, 2013. "Markov switching models in asset pricing research," Chapters, in: Adrian R. Bell & Chris Brooks & Marcel Prokopczuk (ed.), Handbook of Research Methods and Applications in Empirical Finance, chapter 1, pages 3-44, Edward Elgar Publishing.
    11. Basak, Suleyman, 2005. "Asset pricing with heterogeneous beliefs," Journal of Banking & Finance, Elsevier, vol. 29(11), pages 2849-2881, November.
    12. Munk, Claus, 2015. "Financial Asset Pricing Theory," OUP Catalogue, Oxford University Press, number 9780198716457.
    13. Basak, Suleyman, 2004. "Asset Prices with Heterogenous Beliefs," CEPR Discussion Papers 4256, C.E.P.R. Discussion Papers.
    14. Jacoby, Gady & Lee, Gemma & Paseka, Alexander & Wang, Yan, 2019. "Asset pricing with an imprecise information set," Pacific-Basin Finance Journal, Elsevier, vol. 53(C), pages 82-93.
    15. John Y. Campbell, 1996. "Consumption and the Stock Market: Interpreting International Experience," Harvard Institute of Economic Research Working Papers 1763, Harvard - Institute of Economic Research.
    16. Alexander David & Pietro Veronesi, 1998. "Option Prices with Uncertain Fundamentals: Theory and Evidence on the Dynamics of Implied Volatilities," CRSP working papers 485, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
    17. Bidarkota, Prasad V. & Dupoyet, Brice V. & McCulloch, J. Huston, 2009. "Asset pricing with incomplete information and fat tails," Journal of Economic Dynamics and Control, Elsevier, vol. 33(6), pages 1314-1331, June.
    18. Chabakauri, Georgy, 2010. "Asset pricing with heterogeneous investors and portfolio constraints," LSE Research Online Documents on Economics 43142, London School of Economics and Political Science, LSE Library.
    19. Brandt, M.W.Michael W. & Zeng, Qi & Zhang, Lu, 2004. "Equilibrium stock return dynamics under alternative rules of learning about hidden states," Journal of Economic Dynamics and Control, Elsevier, vol. 28(10), pages 1925-1954, September.
    20. John Y. Campbell, 2000. "Asset Pricing at the Millennium," Journal of Finance, American Finance Association, vol. 55(4), pages 1515-1567, August.

    More about this item

    Keywords

    Pricing kernel restrictions; Convexity; Equilibrium volatility;
    All these keywords.

    JEL classification:

    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ihs:ihsesp:153. 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: . General contact details of provider: https://edirc.repec.org/data/deihsat.html .

    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 CitEc recognized a bibliographic reference but did not link an item in RePEc 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 RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Doris Szoncsitz (email available below). General contact details of provider: https://edirc.repec.org/data/deihsat.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.