A Temporary Equilibrium Model of Asset Pricing

In his seminal paper Samuelson (1965) argues that in an informationally efficient market — not to be confused with an allocationally or Pareto-efficient market — price changes must be unforecastable if they are properly anticipated. Prices follow a random walk and fully incorporate the information and expectations of all market participants. Fama's (1970a) dictum that "prices fully reflect all available information" has become a holy grail among the academic community and triggered virtually hundreds of empirical investigations on market efficiency since then. However, in the late 1980s several studies reported deviations of stock returns behavior from the random walk. Poterba/Summers (1988) and Fama/French (1988a) find significant negative autocorrelation in both real and excess long-horizon returns, while Lo/MacKinlay (1988) detect positive autocorrelation for weekly holding-period returns. The empirical evidence throughout this book has shown that stock returns are predictable to some extent on the basis of global instrument variables. It has been argued in chapter 4 that expected returns vary with the business cycle, and that appropriate instrument variables should be indicators for recent and/or future real activity. Similar to the previous literature, the results in chapter 5 strongly suggested that the time variation of economic risk premiums can explain a considerable fraction of the observed stock return predictability. This chapter attempts to put many things together into a unifying framework. Throughout this book it has been argued that predictability is far from being a symptom of inefficiency or irrationality. Now the focus is explicitly on the underlying economic forces in a general equilibrium model of asset pricing, namely reversion in the stochastic discount factor and consumption smoothing. Specifically, this chapter proposes a model in the spirit of LeRoy (1973) and Lucas (1978) to explain mean reversion and, hence stock return predictability in a consumption-based framework. The goal is to demonstrate empirically that the random walk hypothesis is neither a necessary nor a sufficient condition for rationally determined asset prices. In fact, unforecastable prices do not necessarily imply a well-functioning financial market with rational investors, and forecastable prices need not imply the opposite. While the original version of the efficient market hypothesis implicitly assumes constant expected returns, this is inappropriate because it does not account for time variation in risk.KeywordsBusiness CycleStock ReturnAsset PriceExcess ReturnConsumption GrowthThese keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.

We propose a dynamic equilibrium model of asset prices and trading volume with heterogeneous agents fixed transactions costs. We show that even small fixed costs can give rise to large no-trade regions for each agent's optimal trading policy and a significant illiquidity discount in asset prices. We perform a calibration exercise to illustrate the empirical relevance of our model for aggregate data. Our model also has implications for the dynamics of order flow, bid/ask spreads, market depth, the allocation of trading costs between buyers and sellers, and other aspects of market microstructure, including a square-root power law between trading volume and fixed costs which we confirm using historical US stock market data from 1993 to 1997.

Incentive compatible financial contracts, asset prices, and the value of control

We show that, when stock prices are subject to stochastic mispricing errors, expected rates of return may depend not only on the fundamental risk that is captured by a standard asset pricing model, but also on the type and degree of asset mispricing, even when the mispricing is zero on average. Empirically, the mispricing induced return premium, either estimated using a Kaiman filter or proxied by the volatility and variance ratio of residual returns, is shown to be significantly associated with realized risk-adjusted returns. (JEL G10.G12) In this article we consider the implications of Jensen's inequality for stock prices and expected rates of return in markets that are less than perfectly efficient. In particular, we show that, for securities that are subject to stochastic mispricing relative to a given equilibrium asset pricing model, it is likely that either their prices will fail to be unconditionally rational or their returns will fail to be unconditionally rational, or both. By unconditionally rational prices we mean prices whose unconditional expectations are consistent with the fundamental asset pricing model, and by unconditionally rational returns we mean returns whose unconditional expectations are consistent with the fundamental asset pricing model. For example, a stock that on average trades at 100% of its fundamental value, but whose price fluctuates about the fundamental value, will have an average return that is higher than that predicted by the model that determines the fundamental value. Our use of Jensen's inequality to impose restrictions on prices and returns follows earlier applications of Jensen's inequality to expectations-based theories of asset pricing. For example, Siegel's (1972) paradox, which relies on the inequality, implies that if

This paper presents a theory of equilibrium asset pricing that generalizes the recent work of Connor. The model extends Connor's results to more general sets of asset returns and consumer preferences, introduces production, and provides a framework for analyzing exact and approximate equilibrium asset pricing. The other major contribution of the paper is the introduction of geometric arguments that exploit the properties of induced prefer- ences over assets. This method of analyzing asset pricing provides an intuitively appealing way of analyzing equilibrium asset pricing theories. unifies several well-known asset-pricing models. This paper extends Connor's finite-asset model in a number of directions. These extensions are nontrivial, because they allow the theory to encompass asset-pricing models that were excluded by Connor's assumptions. The second major contribution of the paper is to introduce a method of argument that exploits the geometric properties of induced preferences over assets, and characterizes asset prices using these proper- ties. This technique provides an intuitively appealing way of analyzing asset pricing theories. (For a simple geometric exposition of the main ideas in this paper, see Milne (1987).) 0.2. To place this paper in the context of the literature, it is important to appreciate the development of asset-pricing models over the last two decades. The first-and perhaps the most famous-asset-pricing model is the Capital Asset Pricing Model (CAPM) developed by Sharpe (1964) and Lintner (1965). The model demonstrated a striking result: assuming (i) consumers characterize portfolios in terms of the means and variance of rates of return, (ii) there exists a risk-free asset, and (iii) asset equilibrium; then any asset's expected rate of return could be written as a linear function of the riskless interest rate, and the expected rate of return on the endowment of risky assets (the so-called market portfolio). The original CAPM result was derived from a one period model, but Merton (1973) showed that in a continuous time model where returns could be char- acterized by a diffusion process, the same mean-variance argument could be applied to obtain the CAPM formula. It was well-known that if consumers had von Neumann-Morgenstern prefer- ences, then either quadratic utility and/or multivariate normality of returns were

Under heterogeneous expectations, the mean–variance model of capital market equilibrium is employed to determine the effect restricting short sales has on equilibrium asset prices. Two equivalent markets differing only with respect to short sale restrictions are compared. It is shown that, in general, risky asset prices can either rise or fall due to short sale constraints. However, under a homogeneity of beliefs for the covariance matrix of future prices, short sale constraints will only increase risky asset prices.

Asset Pricing with Idiosyncratic Risk and Overlapping Generations

This article presents a dynamic, rational expectations equilibrium model of asset prices where the drift of fundamentals (dividends) shifts between two unobservable states at random times. I show that in equilibrium, investors’ willingness to hedge against changes in their own “uncertainty” on the true state makes stock prices overreact to bad news in good times and underreact to good news in bad times. I then show that this model is better able than conventional models with no regime shifts to explain features of stock returns, including volatility clustering, “leverage effects,” excess volatility, and time-varying expected returns.

This paper investigates the degree of substitutability between securitized real estate assets and real estate assets whose prices are appraisal‐based. Given the insensitivity of unsecuritized asset's returns to the returns on stock market indices, equilibrium asset pricing models cannot be used to compare these two avenues of investment. Two assets are deemed substitutable if the information sets underlying unbiased, minimum error variance estimates of their pricing parameters are identical. The empirical evidence shows that the prices of the transactions‐based assets—real estate investment trusts and the stock price index of the home building industry—follow a random walk while the prices of the appraisal‐based assets—FRC/NCREIF indices—do not. The variance decompositions of the vector autoregressions also show that the level of economic activity helps predict the price indices of appraisal‐based assets while the stock market index and the term structure of interest rates are better predictors of the prices of transactions‐based assets

Necessity of Transversality Conditions for Infinite Horizon Problems

The 2023 2nd International Conference on Financial Technology and Market Management (FTMM 2023) have been conducted during May 27-28, 2023 in Tianjin, China. This conference aims to bring together leading academic scientists, researchers, and scholars to exchange and share their experiences and research results on all aspects of economics, business, and marketing management. It also provides a premier interdisciplinary platform for researchers, practitioners, and educators to present and discuss the most recent innovations, trends, and concerns as well as practical challenges encountered and solutions adopted in the fields of economics, business, and marketing management.
 More than 70 participants from China, Japan, Malaysia, France, and some other countries attended FTMM 2023. About 30 presentations including 6 plenary talks were presented. The presentations are grouped into 9 areas of particular interest: (1): Economic and monetary crisis, (2): Taxes and regulation, (3): Emerging markets issues, (4): Corporate finance and governance, (5): Asset pricing, investment, and portfolio management, (6): Financial markets, (7): Risk management and quantitative finance, (8) Econometric modeling and empirical issues, (9): Mathematical Finance.
 With best regards,
 Conference Organizing Chair
 Tianjin, China

Asset Pricing in a Production Economy with Heterogeneous Investors

IN MY judgment," maintained William McChesney Martin, Jr., Chairman of the Board of Governors, Federal Reserve System, "we can never under the present margin regulations have the same result that occurred in terms of a financial crash in 1929 through undermargined accounts, low margins resulting in a financial debacle."' A widely used elementary economics textbook claimed, "Margin requirements have exercised an important restrictive influence on security speculation, as contrasted with the uncontrolled period of the late 1920's... Nearly everyone agrees that Federal Reserve margin requirements exercise a healthy restraint on speculative stock purchases in a boom" (Bach, 1963, p. 116). But what evidence is there that margin requirements have the effects claimed? At the December meetings of the American Economic Association, George J. Stigler, in the Presidential address, called on economists to test their assumptions that state regulation of private activity has indeed been successful (Stigler, 1965). This article brings together some data on the efficacy of margin requirements. While the figures can only be considered preliminary, and more data should be collected to test margin requirements, the data that are available and presented here indicate that not one of the aims of the legislation establishing margin requirements has been accomplished.2

Responsible investing: The ESG-efficient frontier

I propose a consumption-based asset pricing model with disappointment aversion to investigate the link between downside consumption risk and expected returns across asset markets. I find that the disappointment model can explain 95% of the cross-sectional variation in size/book-to-market portfolios and more than 80% of the variation in the joint sample of stocks, bonds, and commodity futures. I also show that the performance of the disappointment model is comparable to that of the Fama-French three-factor specification, regardless of the sample frequency (annual, quarterly). Overall, my results indicate that disappointment aversion considerably improves the fit of consumption-based asset pricing models.Received November 27, 2014; editorial decision September 18, 2016 by Editor Stefan Nagel.