Financial Asset Pricing Theory PDF
Preview Financial Asset Pricing Theory
FINANCIAL ASSET PRICING THEORY This page intentionally left blank Financial Asset Pricing Theory CLAUS MUNK 1 3 GreatClarendonStreet,Oxford,OX26DP, UnitedKingdom OxfordUniversityPressisadepartmentoftheUniversityofOxford. ItfurtherstheUniversity’sobjectiveofexcellenceinresearch,scholarship, andeducationbypublishingworldwide.Oxfordisaregisteredtrademarkof OxfordUniversityPressintheUKandincertainothercountries ©ClausMunk2013 Themoralrightsoftheauthorhavebeenasserted FirstEditionpublishedin2013 Impression:1 Allrightsreserved.Nopartofthispublicationmaybereproduced,storedin aretrievalsystem,ortransmitted,inanyformorbyanymeans,withoutthe priorpermissioninwritingofOxfordUniversityPress,orasexpresslypermitted bylaw,bylicenceorundertermsagreedwiththeappropriatereprographics rightsorganization.Enquiriesconcerningreproductionoutsidethescopeofthe aboveshouldbesenttotheRightsDepartment,OxfordUniversityPress,atthe addressabove Youmustnotcirculatethisworkinanyotherform andyoumustimposethissameconditiononanyacquirer BritishLibraryCataloguinginPublicationData Dataavailable ISBN 978–0–19–958549–6 PrintedinGreatBritainbythe MPGPrintgroup,UK LinkstothirdpartywebsitesareprovidedbyOxfordingoodfaithand forinformationonly.Oxforddisclaimsanyresponsibilityforthematerials containedinanythirdpartywebsitereferencedinthiswork. Preface The book is intended to serve as a textbook for a course in Asset Pricing TheoryorAdvancedFinancialEconomics,eitherinaPh.D.programmeorin an advanced Master of Science programme. It will also be a useful reference bookforresearchersandfinanceprofessionals. The overall purpose of the book is that, after reading through and under- standingthebook,thereaderwill • haveacomprehensiveoverviewoftheclassicandthecurrentresearchin theoreticalassetpricing, • beabletoreadandunderstandstate-of-the-artresearchpapersinthefield, • beabletoevaluateanddiscusssuchpapers,and • beabletoapplytheconceptsandresultsofthebooktotheirownresearch projectsortoreal-lifeassetvaluationproblems. Alargepartofthematerialiscoveredbyotherassetpricingtextbooks.The booksbyIngersoll(1987),HuangandLitzenberger(1988),Merton(1992),and (earliereditionsof)Duffie(2001)laidthefoundationformyknowledgeofasset pricingtheoryasagraduatestudent.LaterIhavelearnedalotfromreading thebooksbyLeRoyandWerner(2001),Lengwiler(2004),Cochrane(2005), andAltugandLabadie(2008).Thekeydistinctivefeaturesofmybookarethe following: • A balanced presentation offering both formal mathematical modelling andeconomicintuitionandunderstanding.Mostmajorresultsareformu- latedastheoremswhich,inmostcases,areaccompaniedbymathematical proofs and discussions clarifying the economic meaning and intuition. Readersfromthemathematicalfinanceormathematicaleconomicscom- munitieswillsurelymisssomeprecisioninvariousstatementsanddetails insomeoftheproofs,butIdonotwantthereadertofocusonmathemat- icalquibblesnortopaytoomuchattentiontounlikelyspecialcasesthat need special care—at least not until the main concepts, methods, ideas, andresultsarewellunderstood. • Assetpricingisdevelopedaroundthesingle,unifyingconceptofastate- price deflator. All other valuation techniques and modelling approaches (e.g.factormodels,termstructuremodels,risk-neutralvaluation,option pricingmodels)areseeninconnectionwithstate-pricedeflators. • The book is divided into chapters according to economic concepts and theories,notaccordingtothetypeofmodelused.Thiscontrastswithmost vi Preface other advanced asset pricing textbooks that first contain some chapters presenting concepts and results in a simple one-period setting, then the following chapters present basically the same concepts and results in a multiperiod,discrete-timesetting,andfinallyotherchaptersdothesame in the continuous-time setting. In my view, such an organization of the materialmakesithardforthereadertotaketheintuitionandsimplicity from the one-period and discrete-time settings to the mathematically moredemandingcontinuous-timesetting.Also,theusualdivisionintoa discrete-timepartandacontinuous-timeparttemptslecturersandread- ersnottocoverbothframeworks,whichhastheunfortunateimplication thatthosewhohavestudiedonlythediscrete-timepart(oftenempirically orientedreaders)arenotabletocommunicatewiththosewhohaveonly studied the continuous-time part (often theoretically oriented readers). Good future researchers should be able to handle and understand both discrete-timeandcontinuous-timeassetpricingstudies. • The book covers recent developments in asset pricing research that are notcoveredbycompetingbooks.Forexample,thebookoffersanacces- sible presentation of recursive preferences and shows how asset prices are affected by replacing the usual assumption of time-additive util- ity by recursive utility. In particular, the book goes through the long- run risk model introduced by Bansal and Yaron (2004) which has been very successful in explaining many apparently puzzling empirical asset pricingfindingsand,consequently,isbecomingabenchmarkassetpricing model. • Theexistingadvancedbooksonassetpricingdonotgivemuchattention tohowmodernassetpricingmodelscanbeappliedforvaluingastreamof dividendscomingfromastockoraninvestmentproject.Thebookstypi- callyrepresentthecontentsofagivenassetpricingmodelbyanequation linking the expected return on an asset over a certain period to one or more covariances or ‘betas’ between the asset return and some ‘pricing factors’. While this is useful for empirical studies, where time series of returns and factors are inputs, the formulation is not directly useful for valuing a stream of dividends—although this should be a fundamental application of asset pricing models. In contrast, this book also explains howthemodelsareusedforpricing. • Eachchapterendswithanumberofproblems.Whilethekeypointsare,of course,explainedinthetext,manyoftheproblemsarebasedonresearch papersandofferadditionalinsights—andshowthereaderthathe/shecan handleactualresearchproblems. Thebookdoesnotattempttocoveralltopicsinassetpricingtheory.Some importanttopicsthatareonlybrieflytoucheduponornotdiscussedatallare Preface vii asset pricing in an international setting, liquidity and trading imperfections, heterogeneous information and beliefs, ambiguity about model and para- meters,production-basedassetpricing,andbehaviourialassetpricing.Ifused astheprimaryreadingsinacourse,thebookcanbesupplementedbyselected surveysorresearchpapersonsomeofthesetopics. I have strived to provide references both to all the major original contri- butionspresentedinthebookandtorelevantfurtherreadings.However,the literatureissolargeandsorapidlyexpandingthatIamsurethatIhaveover- lookedanumberofpapersthatwouldhavedeservedmentioning.Ioffermy apologiestoauthorswhomissreferencestotheirwork,butIcanassurethem thattheomissionsarenotintentionalfrommyside. I appreciate comments and corrections from Simon Lysbjerg Hansen and students exposed to earlier versions of these notes in courses at the Univer- sityofSouthernDenmark,AarhusUniversity,theDanishDoctoralSchoolof Finance,andtheGraduateSchoolofFinanceinFinland.Ialsoappreciatethe secretarial assistance and financial support from the University of Southern DenmarkandAarhusUniversitywhereIwasemployedwhilemajorpartsof thisbookwerewritten.IamverygratefultoOxfordUniversityPressandthe peopleIhavebeenintouchwiththerefortheirwillingnesstopublishthebook andtheirremarkablepatienceandprofessionalassistance.Iamindebtedtomy formerteachersandsupervisorsPeterOveChristensenandKristianRisgaard Miltersen who led me into a career in finance research. I also thank all the peopleIhaveworkedwithonresearchprojectsovertheyearsandfromwhom Ihavelearnedsomuch.Finally,IamdeeplygratefultomywifeLeneforher continuingloveandsupport. ClausMunk 1July2012 This page intentionally left blank Contents ListofFigures x ListofTables xi 1. IntroductionandOverview 1 2. Uncertainty,Information,andStochasticProcesses 24 3. Portfolios,Arbitrage,andMarketCompleteness 70 4. StatePrices 95 5. Preferences 149 6. IndividualOptimality 192 7. MarketEquilibrium 249 8. BasicConsumption-BasedAssetPricing 277 9. AdvancedConsumption-BasedAssetPricing 317 10. FactorModels 371 11. TheEconomicsoftheTermStructureofInterestRates 419 12. Risk-AdjustedProbabilities 473 13. Derivatives 501 AppendixA:AReviewofBasicProbabilityConcepts 542 AppendixB:ResultsontheLognormalDistribution 549 AppendixC:ResultsfromLinearAlgebra 552 Bibliography 556 Index 579
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