Questions tagged [asset-pricing]

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Question about pricing kernel definition in "Quality minus junk" paper

I'm reading the paper "Quality minus junk" by Asness et al. published in Review of Accounting Studies (2019). The authors present the following definition of the pricing kernel on page 2: $$ ...
Newbie's user avatar
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17 views

Construct DeFi yield curve

I was wondering if anyone knows how to construct a yield curve for cryptocurrencies (for yTokens like yDAI and yETH for example). It'd be best if yield curves could be dynamic (though I think it could ...
Jenn Gunawan's user avatar
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30 views

Measurement of asset quality

In the context of liquidity risk management in a commercial bank, what are the industry best practices to measure the quality of assets? Is it a percentage between 0 and 100, where the higher the ...
ps0604's user avatar
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1 vote
0 answers
79 views

Claim-augmented market is arbitrage-free

Suppose we have a no-arbitrage market with a risk-free rate $r$ and $d$ risky assets with prices $(S_t)_{t \in \{0,1\}}$. Let's introduce a claim with payout $Y$, and assume that there exists a price $...
John David's user avatar
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32 views

What exactly is the 'continuous asset price model'?

I am reading An Introduction to Financial Option Valuation by Higham. In Chapter 6, the book covers two asset price models, a discrete one and a continuous one. In Section 6.3 (Continuous asset model) ...
herbhofsterd's user avatar
2 votes
0 answers
85 views

Stambaugh inference for Investment Analysis when History Lengths Differ

This pertains to Stambaugh in the JFE (vol. 45, 1997 pp 285-331), and I have a question about Proposition 1 results (page 292). (link) To set the background, let's take the smallest relevant ...
Woodpecker's user avatar
1 vote
0 answers
204 views

IDE to use for Python for Quant Trading [closed]

Dear Quantitative Finance Stack Community, Since many Quantitative propietary trading firms seem to be using Python over alternatives such as STATA. I have now decided to get myself familiar with ...
Julien Maas's user avatar
2 votes
0 answers
154 views

Option-like behaviour of momentum strategy

this may come as rather vague question, since I do not have something very exact issue on my mind. Nevertheless, I think this is an interesting question and must have been thought by some other people ...
blizzard16's user avatar
0 votes
1 answer
122 views

Stochastic representation of a zero-coupon bond

In Chapter 9 of Shreve's book Stochastic Calculus for Finance II, the main theorem is the 9.2.1. Defining the discounting process $D(t)=\mathrm{e}^{-\int_0^t du r(u)}$ and $r(u)$ the, possibly ...
apelle's user avatar
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0 answers
31 views

Alphas vs. portfolio rank w.r.t. factors in Fama-French 3-factor model

In the Fama-French 3-factor model, is there a point in looking at the relationship between the estimated alphas for the 25 test portfolios and the size-rank or value-rank of these portfolios? Also, ...
Richard Hardy's user avatar
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12 views

Error (singularity) in the GRS test applied on portfolios that were used for constructing the Fama-French factors

In the context of the Fama-French 3-factor model, we have six portfolios used for creating the SMB and HML factors: SL, SM, SH, BL, BM, BH. (The notation is: S~small, B~big, L~low, M~medium, H~high). ...
Richard Hardy's user avatar
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1 answer
71 views

Why should investors be compensated for accepting systematic risk? [closed]

Investors should be compensated for accepting systematic risk, as it cannot be diversified. Why do the investors need to be compensated for accepting systematic risk? Because no one can avoid it and ...
Boodombie's user avatar
2 votes
0 answers
30 views

Testing the CAPM a la Fama & MacBeth: specific trade-off between expected return and risk

Fama & MacBeth (1973) test a two-parameter model of market equilibrium by examining whether its implications hold empirically. They work with the following generalization of the model: $$ \tilde ...
Richard Hardy's user avatar
1 vote
0 answers
69 views

Risk adjusted returns for a portfolio relative to CAPM

This is very likely a simple question. When following Lewellen (2015) (open access here), how should I compute alphas for portfolio returns relative to the CAPM and FF3? Do we simply subtract the (...
Julien Maas's user avatar
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1 answer
194 views

Understanding completeness in this simple one-period exercise

Let's consider a one period model (t=0, 1) with one risk-free asset that yields r, and one risky asset. $S_t^j$ will be the value of the asset j=0,1 at time t=0,1, where j=0 is the risk-free asset and ...
Confused Quant's user avatar
1 vote
1 answer
98 views

Fama-MacBeth regressions to predict stock returns; confusion on which steps to use

When following Lewellen (2015) (open access here), I am confused as to whether I need to estimate any lambdas. As I already have values for lagged firm characteristics such as ROA and accruals etc. ...
Julien Maas's user avatar
1 vote
1 answer
43 views

FM regressions for size groups when examining a cross section of expected stock returns

When doing FM regressions for size groups similar to Lewellen (2015) (open access here), should I obtain the cross sectional rolling return window betas using only the size group? (E.g only use large ...
Julien Maas's user avatar
1 vote
0 answers
59 views

Testing one asset pricing model against another a la Cochrane via change in $\hat\alpha' \text{cov}(\hat\alpha,\hat\alpha')^{-1}\hat\alpha$

I am reading section section 14.6 of John Cochrane's lectures notes for the course Business 35150 Advanced Investments. On p. 239-240, he discusses testing one asset pricing model against another. ...
Richard Hardy's user avatar
1 vote
1 answer
46 views

Scaling variables (Fraction vs % vs log) when regressing twelve month returns

Dear Stack community, My question is the following; If my dependent variable is twelve month returns. And as independent variables I have fiscal year variables like ROA and log variables like the log ...
Julien Maas's user avatar
1 vote
0 answers
44 views

Testing one asset pricing model against another a la Cochrane: why this works

I am reading section section 14.6 of John Cochrane's lectures notes for the course Business 35150 Advanced Investments. On p. 239-240, he discusses testing one asset pricing model against another. I ...
Richard Hardy's user avatar
1 vote
1 answer
45 views

Does including an additional pricing factor necessarily reduce the pricing errors?

I am reading section section 14.6 of John Cochrane's lectures notes for the course Business 35150 Advanced Investments. On p. 239-240, he discusses testing one asset pricing model against another. ...
Richard Hardy's user avatar
1 vote
1 answer
100 views

Testing one asset pricing model against another a la Cochrane: a counterexample

I am reading section section 14.6 of John Cochrane's lectures notes for the course Business 35150 Advanced Investments. On p. 239-240, he discusses testing one asset pricing model against another. I ...
Richard Hardy's user avatar
0 votes
0 answers
32 views

Power-utility function for calculating Certainty equivalent

I have a question regarding how i should calculate 3.2-3.4, currently studying for an exam. What i don't get is how to acctually derive the certainty equivalent from the expected utility of gross ...
Jens's user avatar
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2 votes
2 answers
183 views

Testing as in Fama & MacBeth vs. comparing models as in Cochrane's lecture notes

Testing a model against its extension as in Fama & MacBeth (1973) Fama & MacBeth (1973) tested the CAPM against an alternative that the dependence between the expected excess return $E(r_{i,t}^...
Richard Hardy's user avatar
3 votes
0 answers
123 views

Understanding the Intersection of "Advances in Financial Machine Learning" and "Asset Pricing in Stock Market Prediction"

I have been reading "Advances in Financial Machine Learning" by Marcos Lopez de Prado and "Machine Learning in Asset Pricing" by Stefan Nagel, and I noticed that there seems to be ...
RRR's user avatar
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2 votes
0 answers
90 views

French and Fama - Alpha vs Residuals (Error)

When running a regression to empirically test models like CAPM or the Fama and French Model, why do we test the statistical significance of the intercept? Do we ignore the residual error? Why not ...
Lusitano's user avatar
0 votes
0 answers
35 views

Shanken's correction for Fama-MacBeth (1973) generalization of the CAPM

Fama & MacBeth (1973) tested the CAPM against an alternative that the dependence between the expected excess return $E(r_{i,t}^∗)$ and the relative systematic risk $\beta_𝑖$ is nonlinear (namely, ...
Richard Hardy's user avatar
3 votes
1 answer
46 views

What quantities (means, betas) must be constant over time for the GRS test to be valid?

I am interested in testing the CAPM using the GRS test. Consider $N$ assets observed for $T$ time periods. Using the notation of Cochrane "Asset Pricing" (2005), the GRS test amounts to ...
Richard Hardy's user avatar
3 votes
0 answers
142 views

Arbitrage Opportunities in a Two-Zero Coupon Bond Market

Question: Suppose we are in a market where there are only two zero coupon bonds, both with a face value of 100: the first one with a maturity of one year and a price of 90, and the second one with a ...
Roberto Palermo's user avatar
3 votes
1 answer
111 views

Question about the footnote in page 33 of the Asset Pricing and Portfolio Choice Theory by Kerry E. Back

The following question is from Kerry E. Back's textbook, and I struggle with it many days, but I wonder this question could be trivial for expertises. If anyone can help, I will really apreciate it! ...
Maynard's user avatar
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1 vote
0 answers
59 views

How to get a Certain Consumption Equivalent using Epstein-Zin preferences?

In many asset pricing models we use CRRA preferences and Epstein-Zin preferences. Let's say I have an agent that lives $T$ periods with CRRA preferences: $$ V_0 = \sum_{t=0}^{T} \beta^t \frac{C_t^{1-\...
phdstudent's user avatar
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33 views

Complete two-period model with specific replication strategy

Find a complete two-period model in which the unique replication strategy of a call (with a suitably chosen strike) shorts the stock in the first period (i.e. the call price falls if the stock rises ...
Analysis's user avatar
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1 answer
143 views

Complete market without risk-neutral measure

Let $\mathcal{M}$ be a one-period model with $\Omega=\{\omega_1,\omega_2\}$ and $S_t^0=1$ for $t=0,1$. Find a $D$ such that $S^d$, $d=1,...,D$ yields a complete market without a risk-neutral measure. ...
Analysis's user avatar
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2 votes
0 answers
200 views

Counterexample for the Second fundamental theorem of Asset Pricing

so the The Second Fundamental Theorem of Asset Pricing says: An arbitrage-free market (S,B) consisting of a collection of stocks S and a risk-free bond B is complete if and only if there exists a ...
Analysis's user avatar
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4 votes
0 answers
90 views

How to calculate the discount rate from yield when adequate price data does not exist [closed]

I'm creating a pricing model for an asset that is similar to a bond, for which I need a discount rate. Using yield to calculate this discount rate was my first thought, but this seems impossible for ...
user68199's user avatar
4 votes
0 answers
229 views

Principal Portfolios Prediction Matrix estimation (Bryan Kelly)

I have recently discovered Bryan Kelly's paper on Principal Portfolios (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3623983) and had some doubts about the prediction matrix $\Pi$. He defines $\...
SL133's user avatar
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1 vote
0 answers
43 views

GRS test does not reject a scalar multiple of the market factor

I have been playing with the GRS test (see my R script below) in relation to Why not use a time series regression when the factor is not a return?. I generated a $10,000\times 26$ matrix of returns on ...
Richard Hardy's user avatar
2 votes
1 answer
183 views

GRS test does not reject a nonsense factor in place of the market factor

I have been playing with the GRS test (see my R script below) in relation to Why not use a time series regression when the factor is not a return?. I generated a $630\times 26$ matrix of returns on 25 ...
Richard Hardy's user avatar
1 vote
0 answers
107 views

Understanding mean-variance tautology from Roll's critique

One of the points of Roll's critique (Roll, 1977) can be summarized as follows (quoting Wikipedia): Mean-variance tautology: Any mean-variance efficient portfolio $R_{p}$ satisfies the CAPM equation ...
Richard Hardy's user avatar
6 votes
2 answers
512 views

Why not use a time series regression when the factor is not a return?

I am trying to wrap my head around the statement that time series regression should not be used for testing a factor model when the factor is not a return. This has been mentioned in multiple posts, ...
Richard Hardy's user avatar
3 votes
1 answer
109 views

Nominal vs. real (inflation-adjusted) prices/returns in cross-sectional asset pricing

I have the impression that asset pricing models such as the CAPM or Fama & French 3 factor model typically concern nominal rather than real (inflation-adjusted) prices/returns. If this is indeed ...
Richard Hardy's user avatar
5 votes
0 answers
259 views

Testing asset pricing models with Roll's critique in mind

Roll's critique (Roll, 1977) can be summarized as follows (quoting Wikipedia): Mean-variance tautology: Any mean-variance efficient portfolio $R_{p}$ satisfies the CAPM equation exactly: $$ E(R_{i})-...
Richard Hardy's user avatar
2 votes
0 answers
55 views

Benchmark Model for Path-Dependant Monte Carlo Simulations?

As part of my research for my masters thesis, I'm testing out the effectiveness of some different models in Monte Carlo simulations for path dependant options. I will be attempting a model-free ...
Rudy S's user avatar
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2 votes
0 answers
44 views

Pricing equation with two correlated states

Consider the following asset pricing setting for a perpetual defaultable coupon bond with price $P(V,c)$, where $V$ is the value of the underlying asset and $c$ is a poisson payment that occurs with ...
Luca Gi's user avatar
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0 votes
1 answer
52 views

Non-stationarity and repricing as a source of idiosyncratic and systematic "risk"?

1.Assuming a one period economy with two assets in which cash flows are assigned certain probabilities, using the CAPM, we can derive the P0 given the E(CF) at t1. Within this distribution, we have ...
Leonid Konoplev's user avatar
1 vote
0 answers
16 views

If investors face different tax rates, how can an asset pricing model be built so that it satisfies the incentive constraints of both investors?

The CAPM and other models have been expanded to include the impact of corporate/personal taxes. However, what if these tax rates differ for an investor pool holding the same equity stake (which by ...
lkonoplev's user avatar
2 votes
1 answer
70 views

Beyond the mean-variance framework, can expected returns be HIGHER for an individual due to a HIGHER risk aversion?

In the mean-variance framework, the only way to get a higher expected return is to be exposed to a higher beta, and the more risk-averse an agent, the lower the beta of their portfolio (lending ...
lkonoplev's user avatar
6 votes
1 answer
270 views

Why can I use equilibrium asset pricing models to predict future returns?

This is a general question that applies to the CAPM and any version of the APT (e.g. the Fama & French three factor model). Speaking in terms of the APT: Assuming a simple one-index version of the ...
shenflow's user avatar
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1 vote
0 answers
26 views

In traditional asset pricing and valuation, why does the cost of equity increase with the AMOUNT of leverage but not with DEFAULT RISK? [closed]

When a firm's default risk increases, the cost of debt obviously rises, which increases the WACC and decreases firm value. However, what happens to the cost of equity in this case? Has the proportion ...
lkonoplev's user avatar
1 vote
0 answers
23 views

Financial constraints, stock return and R&D [closed]

I am doing research on "Financial constraints, stock return and R&D in India". we have constructed the Financial constraints index with the help of Kaplan and Zingles (1997) and Lamont ...
Priya's user avatar
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