Questions tagged [asset-pricing]

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22 views

GRS TEST decision rule [closed]

I have a question regarding the interpretation of the GRS test. I have already looked into a question previously posed by some other users. One can find it here: how to interpret the GRS F test values?...
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32 views

Pricing binary options

A binary option pays an amount of money if an event takes place and zero otherwise. Binary options are usually used to insure portfolios against large drops in the stock market. On March 25, 2021 the ...
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15 views

Inflation and growth due to inflation canceling out in cap rate formula?

A cap rate can be described as: K = RFRr + i + RPi + RPp – Gr – Gi + D Where K = cap rate RFRr is the real risk free rate, or index-linked bond i = average expected inflation RPi = the inflation risk ...
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2answers
105 views

How does one actually create a derivative of a given underlying security? [closed]

Let's say I'm an investment bank and I want to create a derivative whose value tracks that of gold. I don't want this derivative to in any way trade in the underlying security, so no futures or ...
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1answer
79 views

Misconception about replicating portfolio [closed]

I am solving a problem in which following payoff is provided: With $S_0=100$ and $T=8$. Looking at the payoff it seems obvious that it is replicated with two european put options ($K=100$ and $K=150$)...
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38 views

Alpha - Time Series vs Cross Section Approach

I am currently reading Cochranes book on asset pricing. However, I get confused about one thing. He says that one could test a factor model (I will use the CAPM, just as he does), via a time series ...
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1answer
127 views

Does CRR Model lose completeness if we add another instrument?

Consider the multiperiod binomial/CRR model with one risky asset $S^{1}$ and a numeraire $S^{0}$. By seeing that the equivalent martingale measure is uniquely determined, we obtain that the market is ...
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39 views

Hypothetic derivative that absorbs underlying volatility

Market participants are usually assumed to be risk-averse and striving to improve the Sharpe ratios of their portfolios. Thus, if we have an asset A, which is expected to return between \$900 and \$...
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68 views

SDF derivation by a stochastic process

I have a stochastic process to model the stochastic discount factor (SDF) with M: \begin{equation} dM_t = aM_tdt + bM_t d Z_t \end{equation} where, $Z_t$ is a standard brownian motion. How do I show ...
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3answers
77 views

How to calculate a Corporate Bond Transaction Price (Bond returns?)?

I am struggling with the concepts and variables of corporate bonds returns. Bai, Bali and Wen (2019) define monthly corporate bond returns as: Where where is transaction price, , is accrued ...
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5answers
382 views

What mechanisms does the market use to brining an asset back to the market line, as defined by CAPM?

The Capital Asset Pricing Model (CAPM) model states that, on efficient market, expected return of an asset should be given by a linear function of its volatility (as measure by standard deviation of ...
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59 views

linear stochastic discount factor

I have heard some people say something like the following with regards to APT: Let returns be given by the factor model $r_t = B_tf_t + e$ with $E(f_t) = \lambda_t$ Assume that factors are ...
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1answer
1k views

Is market price of risk always negative?

I might have a gap in understanding, so clarifying: Basic pricing equation $E(R) = - cov(m, R)$ where $R$ = excess return and $m$ = stochastic discount factor (I think this is continuous case, in ...
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1answer
356 views

Anyone has detailed explanation on how to use epstein-zin preferences in asset pricing models

I'd be interested to know how Epstein-Zin preferences are used in, say, consumption-based asset pricing models. I'm looking for specific derivations (how you get the SDF) and possible numerical ...
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1answer
212 views

Covariance, stochastic discount factor (SDF) and risk aversion

John Cochrane states, that if the covariance between the stochastic discount factor and the payoff is zero - then risk aversion should have no impact on the pricing. I do not fully understand why this ...
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1answer
108 views

SML Interpretation

I follow this paper and estimated two different asset pricing models via systems of deep neural networks. Both models have the exact same input: firm-specific features for 10'000 (unique) US stocks ...
3
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1answer
143 views

Why are some metals in contango (inverted) forward curve and some in backwardation (normal) forward curve?

I am scrolling through the various metals on lme.com and some are in contango and some in backwardation. For example: Copper: backwardation Aluminium: contango Further examination of other metals ...
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41 views

By how much do specific asset correlations increase during a market downturn?

It is well-known that asset return correlations of stocks increase during market downturns. But are there any general properties derived from empirical observation or evidence regarding by how much ...
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1answer
199 views

ETF pricing papers

May I request for research paper recommendations, if any, on existing models that study how the presence of ETFs affect equilibrium prices of the underlying assets? I am exploring a project on a ...
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0answers
27 views

No Arbitrage condition for assets with different time frame

In the classic literature, one always assumes that the assets in the market are all available from the very beginning ($t=0$). And under such condition the market is arbitrage free iff there exists an ...
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62 views

Stocks with same volatility but different drifts

In the book Quant Job Interview Questions & Answers, in section 2, question 2.4 says suppose two assets in a Black-Scholes world have the same volatility but different drifts. How will the price ...
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1answer
160 views

What are industry fixed effects?

I have come across the term "industry fixed effects" in some papers in relation to cross sectional regressions in asset pricing. I know what "fixed" regression models are, but not ...
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1answer
78 views

How is CAPM used to price an asset once it has been used to derive the assets expected return?

As I understand it (correct me if I'm wrong) the theoretical price of an asset should be the present value of all future cash-flows that it is expected to yield, discounted at the risk-free rate. I am ...
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0answers
46 views

Question on the details of certain parameters in Sharpe Ratio [closed]

I'm puzzled about certain parameters in calculating the annualized Sharpe Ratio using monthly return data. Average excess return: Does this mean the arithmetic average of all the monthly excess ...
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2answers
294 views

Cashflow Risk vs Discount Risk

Studying asset pricing, I often hear the terms cashflow risk and discount risk but I'm not sure what they mean? The Campbell/Shiller (1988) decomposition includes cashflows (future dividends) and ...
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1answer
93 views

Vasicek model - Bond price and volatility

Why does the bond price under the Vasicek model increase as the rate volatility increases? What is the intuition behind this?
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2answers
278 views

Clean vs dirty price for bonds

Why the clean price is mostly quoted in the US bond markets and the dirty price is mostly quoted in the European bond markets?
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1answer
83 views

How to simulate asset prices/returns that display market regimes?

Are there any techniques that can make a multivariate random number generating process for stock prices/returns, like geometric Brownian motion via Cholesky, also include the simulation of a finite ...
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0answers
37 views

Some questions to canonical correlations between principle components and asset pricing factors using R

I have done a asympotical principle component analysis (APCA), using eigen() in R, of the covariance matrix of a global dataset of excess returns. I took the ...
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0answers
43 views

Use of Macaulay Duration to calculate the Funds Transfer Pricing Cost of an Amortizing Mortgage

I am asked to comment on the Funds Transfer Pricing methodology used by our Treasury to assign a Cost of Funds to a Loan. This is the current methodology: Let us say there is a 2 year loan with an ...
3
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1answer
173 views

GRS Test in R with robust residuals

I'm testing certain asset pricing factor models (e.g. Fama and French 3 factor model) and want to check if the alphas of my time series regressions are jointly zero. Most papers use the Gibbons, Ross,...
6
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1answer
195 views

SDF as an affine transformation of the tangency portfolio

I'm studying this paper. In the formulation of the theoretical setup they state: Our goal is to explain the differences in the cross-section of returns $R$ for individual stocks. Let $R_{t+1, i}$ ...
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0answers
70 views

Arbitrage strategy from Arrow Securities

I had this exercise and I calculated the prices of the Arrow Securities, π1 = 0.5 and π2 = -0.2. I know that π2 is not arbitrage-free because -0.2 < 0, but I do not understand that how to interpret ...
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1answer
89 views

Can we use risk-neutral pricing to price a stock or a bond?

Can you please tell me whether if I can used risk-neutral pricing approach to price a stock or a bond ? (i.e. discount with risk free rate the future cashflows) ? Thank you very much!
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3answers
611 views

Asset pricing textbooks

What are some asset pricing textbooks that give a solid introduction into the field? I suggest one textbook per answer with a list of its pros and cons.
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78 views

Stock Price as Numeraire, Two Stocks & One Money Market Account

We have two uncorrelated Stock price processes and the classical Money-Market (MM) account. Under the MM Numeraire, both stocks are Martingales when discounted by the MM, as usual. Question: I would ...
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1answer
503 views

Numeraire correlated to the traded asset

The Fundamental Theorem of Asset Pricing states that: \begin{align*} \frac{X_0}{N_0} &= \mathbb{E}^N{ \left[ \frac{X(t)}{N(t)}|\mathcal{F}_0 \right] } \end{align*} The usual conditions apply (both ...
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0answers
46 views

Applying GRS-test on non-normal residuals with autocorrelation

Is it valid to apply GRS-test (Gibbons, Ross and Shanken 1989) on non-normal and autocorrelated residuals? I got residuals using 10 test-assets regressed on 3-factor and carhart. If it is valid, how ...
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2answers
111 views

Asset Pricing and inferences - Intercept and relationship to returns

Ideally this question is very similar to What's the meaning of the intercept in asset pricing model? I am regressing a "buys minus sells" portfolio returns to the Carhart factors. The intercept ...
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1answer
94 views

true or false: the risk-neutral measure is useless in this situation

Example 2 of this Wiki article on the risk-measure describes how a stock price $S_t$ that is modeled with Geometric Brownian motion with drift $\mu$ $$ dS_t = \mu S_t dt + \sigma S_t dW_t $$ can be ...
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20 views

Adding an economic policy uncertainty (EPU) variable to Fama French model

I would like to do test the significance of a new variable that I would include in the Fama French 5 factor model. The new variable would be the Economic Policy Uncertainty (EPU) index from Baker et ...
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1answer
103 views

Risk Neutral Pricing, a quick question [closed]

I am a newbie. The risk neutral pricing has the following formulation: $$P=\frac{\hat{E(d)}}{R}$$, But the discounted expected value has the formulation of: $$P=\frac{E(d)}{R}$$. The text book ...
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0answers
84 views

Fama Macbeth and Momentum factor

I am working on a Fama MacBeth regression with excess returns on the LHS and Size, Value an Momentum factors on the RHS. In literature, the Momentum factor is often definded as the cumulative past 6 ...
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0answers
54 views

How to find the derivative for a multi-factor geometric brownian motion model

Does anyone know how to find the derivative for a multi-factor geometric brownian motion model $ \frac { dS_{i}}{S_{i}} $. I have seen solutions for the standard GBM model however I suspect that the ...
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0answers
61 views

How do I maximize my expected utility of wealth?

Suppose I have a utility function say $U(p)=p^{1/2}$ and I bet on a basketball game. I have my initial investment, payouts and probabilities of winning, how can I determine the maximum I need to bet ...
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0answers
97 views

CAPM and the Fama-MacBeth (1973)

I need to conduct the Fama-MacBeth (FM) procedure for my thesis to test the ability of the six-factor model to predict future expected returns. In univariate regressions of expected excess returns on ...
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1answer
284 views

Returns on the Fama-French size sorted portfolios

For my thesis, I need to replicate a specific research paper in the field of empirical asset pricing, mentioning the CAPM in particular. The data mainly consists of monthly returns on portfolios ...
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1answer
719 views

Bond quotes to EDSF

I am having a hard time understanding what "EDSF" (Eurodollar Synthetic Forward Curve) represents as a bond pricing benchmark. I have seen bonds quoted as spreads to EDSF with maturities < 2 years ...
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25 views

Bond agreggation

I'm working on an asset and liabilities model for life insurance as a school project, one of the inputs of the model is a bond portfolio, for the sake of optimization of computation speed (the model ...
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0answers
17 views

CS-Regression Three Factor Model

1# When would the three risk factors market, size and value be priced in the FF Three factor model when performing cs-regression? How do you know that they are priced? 2# How would it be possible to ...

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