Asset pricing using finite state Markov chain stochastic discount functions
Date
2012
Authors
Van Der Hoek, J.
Elliott, R.
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Journal article
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Stochastic Analysis and Applications, 2012; 30(5):865-894
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John van der Hoek and Robert J. Elliott
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Abstract
This article fuses two pieces of theory to make a tractable model for asset pricing. The first is the theory of asset pricing using a stochastic discounting function (SDF). This will be reviewed. The second is to model uncertainty in an economy using a Markov chain. Using the semi-martingale dynamics for the chain these models can be calibrated and asset valuations derived. Interest rate models, stock price models, futures pricing, exchange rates can all be introduced endogenously in this framework.
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