528:. Here, "in the absence of arbitrage, the market imposes a probability distribution, called a risk-neutral or equilibrium measure, on the set of possible market scenarios, and... this probability measure determines market prices via discounted expectation". Correspondingly, this essentially means that one may make financial decisions, using the risk neutral probability distribution consistent with (i.e. solved for) observed equilibrium prices. See
547:(a currency or a commodity) if a particular state occurs at a particular time, and zero otherwise. The approach taken is to recognize that since the price of a security can be returned as a linear combination of its state prices, so, conversely, pricing- or return-models can be backed-out, given state prices. The CAPM, for example,
878:
413:
In general this approach does not group assets but rather creates a unique risk price for each asset; these models are then of "low dimension". For further discussion, see
478:
Rational pricing is also applied to fixed income instruments such as bonds (that consist of just one asset), as well as to interest rate modeling in general, where
316:. Here asset prices jointly satisfy the requirement that the quantities of each asset supplied and the quantities demanded must be equal at that price - so called
270:, outlined below, together with the resultant models. There have been many models developed for different situations, but correspondingly, these stem from either
329:
86:
328:(CAPM) as the prototypical result. Prices here are determined with reference to macroeconomic variables–for the CAPM, the "overall market"; for the
211:
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231:
732:
375:
147:
525:
519:
106:
382:, which instead relies on accounting information, attempting to model return based on the company's expected financial performance.)
182:
157:
845:
201:
630:
556:
868:(2012). Introduction to Contingent Claims Analysis, in Encyclopedia of Financial Models, Frank Fabozzi ed. Wiley (2012)
347:. General equilibrium pricing is then used when evaluating diverse portfolios, creating one asset price for many assets.
216:
900:
584:
339:
of the market prices of "all" securities at a given future investment horizon; they are thus of "large dimension". See
226:
177:
428:" - i.e. the asset pricing model selected, with its parameters having been calibrated to observed prices; and (ii) a
325:
243:
81:
378:. (Note that an alternate, although less common approach, is to apply a "fundamental valuation" method, such as the
206:
137:
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548:
305:
271:
920:
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728:
568:
111:
499:
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336:
118:
448:
444:
127:
370:- of these cashflows; (iii) these present values are then aggregated, returning the value in question. See:
777:
491:
321:
293:
536:
498:. For discussion as to how the models listed above are applied to options on these instruments, and other
101:
821:
495:
472:
152:
196:
714:
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344:
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39:
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at the rate returned by the model selected; this rate in turn reflecting the "riskiness" - i.e. the
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836:
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657:
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433:
236:
894:
879:
Risk-neutral probability density functions from option prices: theory and application
865:
552:
359:
172:
38:. For the valuation of derivatives and interest rate / fixed income instruments, see
540:
479:
309:
142:
17:
424:, i.e. sensitivities, combines: (i) a model of the underlying price behavior, or "
284:, which is near synonymous, encompasses the body of knowledge used to support the
751:
483:
132:
76:(and foreign exchange and commodities; interest rates for risk neutral pricing)
653:
564:
456:
403:
289:
221:
406:(equilibrium determined) securities prices; for an overview of the logic see
839:(2005). "Great Moments in Financial Economics: IV. The Fundamental Theorem (
544:
399:
459:
process; the other models will, for example, incorporate features such as
447:
which describes the dynamics of a market including derivatives (with its
778:"Risk and Return in Equilibrium: The Capital Asset Pricing Model (CAPM)"
673:
379:
567:(i.e. states) and then rearranging for the terms in its formula. See
535:
Relatedly, both approaches are consistent with what is called the
688:
436:
of option payoffs over the range of prices of the underlying. See
292:, and the asset pricing models are then applied in determining the
530:
Financial economics § Arbitrage-free pricing and equilibrium
267:
555:
to overall market return, and restating for price. Black-Scholes
332:, overall wealth– such that individual preferences are subsumed.
266:
refers to a formal treatment and development of two interrelated
455:, as well as the above listed models. Black–Scholes assumes a
350:
Calculating an investment or share value here, entails: (i) a
354:
for the business or project in question; (ii) where the
335:
These models aim at modeling the statistically derived
484:
with respect to the prices of individual instruments
278:, the latter corresponding to risk neutral pricing.
30:This article is about the economic theory. For the
432:which returns the premium (or sensitivity) as the
658:"The Arbitrage Principle in Financial Economics"
488:Rational pricing § Fixed income securities
539:. Here models can be derived as a function of "
524:These principles are interrelated through the
590:Outline of finance § Asset pricing theory
8:
832:
830:
408:Rational pricing § Pricing derivatives
341:§ Risk and portfolio management: the P world
27:How equities and debt instruments are valued
595:Outline of finance § Portfolio theory
438:Valuation of options § Pricing models
44:
689:"An Introduction to Asset Pricing Theory"
818:The Fundamental Theorem of Asset Pricing
648:
646:
644:
642:
606:
167:Bonds, other interest rate instruments
573:Financial economics § Uncertainty
294:asset-specific required rate of return
849:, Vol. 3, No. 4, Fourth Quarter 2005;
791:"An Overview of Asset Pricing Models"
720:An Introduction to Investment Theory
543:" - contracts that pay one unit of a
420:Calculating option prices, and their
376:Valuation using discounted cash flows
7:
855:, Vol. 4, No. 1, First Quarter 2006.
585:List of financial economics articles
526:fundamental theorem of asset pricing
520:Fundamental theorem of asset pricing
372:Financial modeling § Accounting
415:§ Derivatives pricing: the Q world
398:are calculated such that they are
25:
300:General equilibrium asset pricing
272:general equilibrium asset pricing
846:Journal of Investment Management
320:. These models are born out of
296:on the investment in question.
308:prices are determined through
107:Fama–French three-factor model
1:
563:to each of numerous possible
508:Heath–Jarrow–Morton framework
451:); leading more generally to
443:The classical model here is
417:under Mathematical finance.
326:capital asset pricing model
82:Capital asset pricing model
937:
623:Princeton University Press
517:
306:general equilibrium theory
29:
753:Macro-Investment Analysis
729:Yale School of Management
569:Contingent claim analysis
500:interest rate derivatives
112:Carhart four-factor model
64:
59:
877:Bhupinder Bahra (1997).
337:probability distribution
212:Kalotay–Williams–Fabozzi
119:Arbitrage pricing theory
492:Bootstrapping (finance)
482:must be arbitrage free
322:modern portfolio theory
449:option pricing formula
402:-free with respect to
276:rational asset pricing
102:Multiple factor models
87:Consumption-based CAPM
822:University of Chicago
662:Economic Perspectives
518:Further information:
496:Multi-curve framework
473:stochastic volatility
244:Brace–Gatarek–Musiela
46:Asset pricing models
715:William N. Goetzmann
561:binomial probability
368:undiversifiable risk
345:Mathematical finance
288:process of choosing
40:Mathematical finance
901:Financial economics
864:Edwin H. Neave and
762:Stanford University
537:Arrow–Debreu theory
430:mathematical method
260:financial economics
232:Heath–Jarrow–Morton
47:
36:Valuation (finance)
18:Asset pricing model
735:2008-08-05 at the
465:volatility surface
453:martingale pricing
352:financial forecast
268:pricing principles
249:LIBOR market model
217:Longstaff–Schwartz
183:Cox–Ingersoll–Ross
158:Korn-Kreer-Lenssen
97:Single-index model
92:Intertemporal CAPM
45:
798:people.bath.ac.uk
748:William F. Sharpe
514:Interrelationship
467:aware", applying
396:derivative prices
314:supply and demand
282:Investment theory
256:
255:
227:Rendleman–Bartter
178:Rendleman–Bartter
32:corporate finance
16:(Redirected from
928:
921:Finance theories
916:Financial models
885:
875:
869:
866:Frank J. Fabozzi
862:
856:
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825:
820:(course notes).
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789:Andreas Krause.
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615:John H. Cochrane
611:
504:short-rate model
469:local volatility
404:more fundamental
392:Rational pricing
386:Rational pricing
356:output cashflows
207:Black–Karasinski
202:Black–Derman–Toy
138:Garman–Kohlhagen
48:
21:
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837:Mark Rubinstein
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816:Steven Lalley.
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654:Varian, Hal R.
638:
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557:can be derived
549:can be derived
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434:expected value
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619:Asset Pricing
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128:Black–Scholes
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65:Risk neutral
50:
49:
41:
37:
33:
19:
873:
860:
844:
812:
801:. Retrieved
797:
784:
768:
752:
743:
719:
710:
699:. Retrieved
695:
682:
668:(2): 55–72.
665:
661:
618:
609:
541:state prices
534:
523:
480:yield curves
477:
442:
419:
412:
389:
349:
334:
303:
281:
280:
263:
257:
60:Equilibrium
772:See, e.g.,
565:spot-prices
551:by linking
324:, with the
290:investments
56:Asset class
34:usage, see
895:Categories
851:~ (2006).
803:2018-12-16
701:2018-12-16
696:jhqian.org
632:0691121370
601:References
457:log-normal
360:discounted
197:Hull–White
758:hypertext
725:hypertext
545:numeraire
400:arbitrage
358:are then
73:Equities
776:(2019).
750:(n.d.).
733:Archived
717:(2000).
656:(1987).
617:(2005).
579:See also
422:"Greeks"
237:Cheyette
67:pricing
62:pricing
911:Pricing
853:Part II
674:1942981
426:process
380:T-model
173:Vasicek
841:Part I
672:
629:
502:, see
494:, and
486:. See
390:Under
374:, and
343:under
304:Under
192:Ho–Lee
143:Heston
52:Regime
906:Asset
794:(PDF)
692:(PDF)
670:JSTOR
366:, or
330:CCAPM
133:Black
843:)",
627:ISBN
506:and
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153:SABR
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756:(
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