The emphasis is on the interplay between theory and empirical work and on the tradeoff between risk and return. 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 market clearing. It is considered to be an alternative to the capital asset pricing model as a method to explain the returns of portfolios or assets. Asset pricing theory is an advanced textbook for doctoral students and researchers that offers a modern introduction to the theoretical and methodological foundations of competitive asset pricing. On the other hand, the creation of assets is done through investment. Using finite dimensional techniques, this book avoids sophisticated mathematics and exploits economic theory to clarify the essential structure of recent research in asset pricing. Empirical asset pricing the graduate school of finance. Pareto optimality implies a representative investor 163 7. The capital asset pricing model the capital asset pricing model capm is a theory in which the expected return on an asset is the sum of the return on a riskfree asset and the return commensurate with the assets market risk. Eugene fama is one of the worlds most cited economists in any eld. The last part of the chapter is devoted to the fundamental theorem of asset pricing, which relates the absence of arbitrage opportunities to the existence of a strictly positive linear pricing.
Monetary economics this article compares two leading models of asset pricing. Asset pricing in the standard assetpricing paradigm, it is assumed that investors directly invest their wealth in markets. Modern research seeks to understand the behavior of the stochastic discount factor sdf. The asset pricing results are based on the three increasingly restrictive assumptions. Theory and evidence 29 thus, j3im is the covariance risk of asset i in m measured relative to the average covariance risk of assets, which is just the variance of the market return.
Asset pricing wikibooks, open books for an open world. The aim of this course is to introduce students to the modern theory of asset pricing, portfolio theory and derivatives pricing. Assuming a basic knowledge of graduate microeconomic theory, it explores the fundamental ideas that underlie competitive financial asset pricing models with symmetric information. Pdf asset pricing theory princeton series in finance. Financial asset pricing theory, 20, 585 pages, claus. Arbitrage pricing theory, often referred to as apt, was developed in the 1970s by stephen ross. A simple version of the ccapm cannot explain various stylized asset pricing facts, but these asset pricing puzzles can be resolved by a number of recent extensions involving habit formation, recursive utility, multiple consumption goods, and longrun consumption risks.
Topics covered include i noarbitrage, arrowdebreu prices, and equivalent martingale measures, ii security structure and market completeness, iii meanvariance analysis. It will inform even experienced researchers about the fundamental assumptions necessary for deriving pricing implications from quite general, recursive, preferences. Arbitrage pricing theory apt an alternative model to the capital asset pricing model developed by stephen ross and based purely on arbitrage arguments. Merton, robert 1973, an intertemporal capital asset pricing model, econometrica 41, 867887. Assuming that the wellbeing of an individual can be represented by some sort of utility function, we will have to maximize utility subject to various constraints, e. In this chapter, we shall introduce the basic theory of asset pricing and portfolio management in the discrete time case. This book is the frontier text for learning asset pricing theory from first principles. Finance theory and asset pricing, second edition oxford university press 2003. Description theory of asset pricing unifies the central tenets and techniques of asset valuation into a single, comprehensive resource that is ideal for the first phd course in asset pricing. Finance theory and asset pricing frank milne oxford.
Under general equilibrium theory prices are determined through market pricing by supply and demand. For debt, asset pricing is relatively simple, as cash flows to the owner are contractually fixed. In finance, arbitrage pricing theory apt is a general theory of asset pricing that holds that the expected return of a financial asset can be modeled as a linear function of various factors or theoretical market indices, where sensitivity to changes in each factor is represented by a factorspecific beta coefficient. Capital asset pricing model and arbitrage pricing theory. By striking a balance between fundamental theories and cuttingedge research, pennacchi offers the reader a wellrounded introduction to modern asset pricing theory that does not require a high level of. The password for opening the files will be sent to the students. For all the sessions students will need the class notes, the data files and a laptop with matlab. The model can justify the equity premium, the risk. Other more advanced references that may be used in class or consulted on specific topics. An overview of asset pricing models university of bath.
Litzenberger, foundations for financial economics, north holland. A theory of market equilibrium under conditions of risk, journal of finance 19, 425442. Asset pricing is developed around the concept of a stateprice deflator which relates the price of any asset to its future risky dividends and thus incorporates how to adjust for both time and risk in asset. Theme a new class of capital asset pricing models arises from the rst principle of real investment for individual rms. An overview of asset pricing models andreas krause university of bath school of management phone.
The capital asset pricing model and the arbitrage pricing. I will start with a discussion of asset pricing and then turn to corporate finance. These models are born out of modern portfolio theory, with the capital asset pricing. I argue that while the apt is compatible with the data available for testing theories of asset pricing, the capm is not. Asset pricing the authors model consumption and dividend growth rates as containing both a small longrun predictable component and fluctuating economic uncertainty consumption volatility. Undoubtedly, the capital asset pricing model capm developed by sharpe 1964, lintner 1965, and mossin 1966 is the best known asset pricing model. The capital asset pricing model capm provides an initial framework for answering this question. Asset pricing theory tries to understand the prices or values of claims to uncertain payments. When implemented correctly, it is the practice of being able to take a positive and. The asset prices we discuss would include prices of bonds and stocks, interest rates, exchange rates, and derivatives of all these underlying.
To see why the assumption of frictionless market is crucial, consider the basic principle of standard asset pricing. Fins4776fins5576 asset pricing theory course outline. An integrated pricing model for defaultable loans and bonds jel classification. Markowitz is best known for his initiation of the modern portfolio choice. These dynamics, for which they provide empirical support, in conjunction with generalized recursive preferences, can explain key asset markets phenomena. The modelderived rate of return will then be used to price the asset. Asset pricing theory phd course the einaudi institute for. Lintner, 1965 marks the birth of asset pricing theory. The development of nancial asset pricing theory over the 35 yr since samuelsons 1965 article has been intertwined with the development of the theory of stochastic integration.
Arbitrage pricing theory assumptions explained hrf. This is a thoroughly updated edition of dynamic asset pricing theory, the standard text for doctoral students and researchers on the theory of asset pricing and portfolio selection in multiperiod settings under uncertainty. Topics include microeconomic foundation of asset pricing theory, the noarbitrage principle and fundamental theorem, risk measurement and risk management, sequential portfolio choice, equity. The fame of the laureates extends far beyond nancial economics. Lecture notes in macroeconomics asset pricing asset pricing sits on the border of two areas of macro. The investment capm lu zhang ohio state and nber busfin 8210 ohio state, autumn 2018.
To study asset pricing theory, we will have to study how individual investors make decisions about consumption and investment. Although this was an appropriate assumption for the united states in. Asset pricing is developed around the concept of a stateprice deflator which relates the price of any asset to its future risky dividends and thus incorporates how to adjust for both time and risk in asset valuation. Asset pricing and portfolio choice theory second edition.
Introduction to asset pricing theory the theory of asset pricing is concerned with explaining and determining prices of. Arbitrage pricing theory apt is a multifactor asset pricing model based on the idea that an assets returns can be predicted using the linear relationship between the assets expected return. Pdf a partial introduction to financial asset pricing. To improve the discrepancy of the capm, the apt model was proposed by stephen ross 1976 as a general theory of asset pricing. Both of them are based on the efficient market hypothesis, and are part of the modern portfolio theory. Thus asset pricing is an extension of consumption theory. Finance theory and asset pricing provides a concise guide to financial asset pricing theory for economists. The key message of the model is that the expected excess return on a risky. Campbell abstract this paper surveys the field of asset pricing. Financial asset pricing theory claus munk download. The capital asset pricing model capm and the arbitrage pricing theory apt have emerged as two models that have tried to scientifically measure the potential for assets to generate a return or a loss. His theory predicts a relationships between the returns of a single asset as a linear function of many independent macroeconomic factors. An investor must decide how much to save and how much to consume, and what portfolio of assets to hold.
A low price implies a high rate of return, so one can also think of the theory as explaining why some assets pay higher average returns than others. October 5, 2015 darrell du e notes that the 1970s were a \golden age for asset pricing theory, but suggests that the period since has been \a moppingup operation du e, dynamic asset pricing theory, preface. In recent years, credit risk has played a key role in risk management issues. Financial asset pricing theory offers a comprehensive overview of the classic and the current research in theoretical asset pricing. Using finite dimensional techniques, this book avoids sophisticated mathematics and exploits. Continuoustime asset pricing theory expresses a rich body of central results in financial economics from the perspective of models in which agents can revise their decisions continuously in time.
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