Asset Pricing

by Cochrane, John H.

• ISBN13: 9780691121376
• ISBN10: 0691121370
• Edition: Revised
• Format: Hardcover
• Copyright: 2005-01-03
• Publisher: Princeton Univ Pr

Summary

Winner of the prestigious Paul A. Samuelson Award for scholarly writing on lifelong financial security, John Cochrane's Asset Pricing now appears in a revised edition that unifies and brings the science of asset pricing up to date for advanced students and professionals. Cochrane traces the pricing of all assets back to a single idea--price equals expected discounted payoff--that captures the macro-economic risks underlying each security's value. By using a single, stochastic discount factor rather than a separate set of tricks for each asset class, Cochrane builds a unified account of modern asset pricing. He presents applications to stocks, bonds, and options. Each model--consumption based, CAPM, multifactor, term structure, and option pricing--is derived as a different specification of the discounted factor.The discount factor framework also leads to a state-space geometry for mean-variance frontiers and asset pricing models. It puts payoffs in different states of nature on the axes rather than mean and variance of return, leading to a new and conveniently linear geometrical representation of asset pricing ideas.Cochrane approaches empirical work with the Generalized Method of Moments, which studies sample average prices and discounted payoffs to determine whether price does equal expected discounted payoff. He translates between the discount factor, GMM, and state-space language and the beta, mean-variance, and regression language common in empirical work and earlier theory.The book also includes a review of recent empirical work on return predictability, value and other puzzles in the cross section, and equity premium puzzles and their resolution. Written to be a summary for academics and professionals as well as a textbook, this book condenses and advances recent scholarship in financial economics.

Author Biography

John H. Cochrane is Myron S. Scholes Professor of Finance, University of Chicago, Graduate School of Business. He is Director of the National Bureau of Economic Research Asset Pricing Program.

Table of Contents

Acknowledgments	v
Preface	xiii
Part I. Asset Pricing Theory	1	(184)
Consumption-Based Model and Overview	3	(32)
Basic Pricing Equation	4	(2)
Marginal Rate of Substitution/Stochastic Discount Factor	6	(2)
Prices, Payoffs, and Notation	8	(2)
Classic Issues in Finance	10	(15)
Discount Factors in Continuous Time	25	(10)
Problems	31	(4)
Applying the Basic Model	35	(14)
Assumptions and Applicability	35	(2)
General Equilibrium	37	(4)
Consumption-Based Model in Practice	41	(2)
Alternative Asset Pricing Models: Overview	43	(6)
Problems	45	(4)
Contingent Claims Markets	49	(12)
Contingent Claims	49	(2)
Risk-Neutral Probabilities	51	(2)
Investors Again	53	(1)
Risk Sharing	54	(2)
State Diagram and Price Function	56	(5)
The Discount Factor	61	(16)
Law of One Price and Existence of a Discount Factor	62	(5)
No Arbitrage and Positive Discount Factors	67	(5)
An Alternative Formula, and X* in Continuous Time	72	(5)
Problems	75	(2)
Mean-Variance Frontier and Beta Representations	77	(22)
Expected Return-Beta Representations	78	(3)
Mean-Variance Frontier: Intuition and Lagrangian Characterization	81	(3)
An Orthogonal Characterization of the Mean-Variance Frontier	84	(4)
Spanning the Mean-Variance Frontier	88	(1)
A Compilation of Properties of R*, Re*, and x*	89	(3)
Mean-Variance Frontiers for Discount Factors: The Hansen-Jagannathan Bounds	92	(7)
Problems	97	(2)
Relation between Discount Factors, Betas, and Mean-Variance Frontiers	99	(22)
From Discount Factors to Beta Representations	100	(3)
From Mean-Variance Frontier to a Discount Factor and Beta Representation	103	(3)
Factor Models and Discount Factors	106	(4)
Discount Factors and Beta Models to Mean-Variance Frontier	110	(1)
Three Risk-Free Rate Analogues	111	(6)
Mean-Variance Special Cases with No Risk-Free Rate	117	(4)
Problems	120	(1)
Implications of Existence and Equivalence Theorems	121	(10)
Conditioning Information	131	(18)
Scaled Payoffs	132	(2)
Sufficiency of Adding Scaled Returns	134	(2)
Conditional and Unconditional Models	136	(8)
Scaled Factors: A Partial Solution	144	(1)
Summary	145	(4)
Problems	146	(3)
Factor Pricing Models	149	(36)
Capital Asset Pricing Model (CAPM)	152	(13)
Intertemporal Capital Asset Pricing Model (ICAPM)	165	(2)
Comments on the CAPM and ICAPM	167	(6)
Arbitrage Pricing Theory (APT)	173	(9)
APT vs. ICAPM	182	(3)
Problems	183	(2)
Part II. Estimating and Evaluating Asset Pricing Models	185	(124)
GMM in Explicit Discount Factor Models	189	(12)
The Recipe	190	(2)
Interpreting the GMM Procedure	192	(4)
Applying GMM	196	(5)
GMM: General Formulas and Applications	201	(28)
General GMM Formulas	202	(4)
Testing Moments	206	(1)
Standard Errors of Anything by Delta Method	207	(1)
Using GMM for Regressions	207	(3)
Prespecified Weighting Matrices and Moment Conditions	210	(8)
Estimating on One Group of Moments, Testing on Another	218	(1)
Estimating the Spectral Density Matrix	219	(10)
Problems	227	(2)
Regression-Based Tests of Linear Factor Models	229	(24)
Time-Series Regressions	230	(5)
Cross-Sectional Regressions	235	(10)
Fama-MacBeth Procedure	245	(8)
Problems	251	(2)
GMM for Linear Factor Models in Discount Factor Form	253	(14)
GMM on the Pricing Errors Gives a Cross-Sectional Regression	253	(3)
The Case of Excess Returns	256	(3)
Horse Races	259	(1)
Testing for Priced Factors: Lambdas or b's?	260	(2)
Mean-Variance Frontier and Performance Evaluation	262	(2)
Testing for Characteristics	264	(3)
Problems	265	(2)
Maximum Likelihood	267	(12)
Maximum Likelihood	268	(2)
ML is GMM on the Scores	270	(2)
When Factors Are Returns, ML Prescribes a Time-Series Regression	272	(3)
When Factors Are Not Excess Returns, ML Prescribes a Cross-Sectional Regression	275	(4)
Problems	277	(2)
Time-Series, Cross-Section, and GMM/DF Tests of Linear Factor Models	279	(14)
Three Approaches to the CAPM in Size Portfolios	280	(6)
Monte Carlo and Bootstrap	286	(7)
Which Method?	293	(16)
Part III. Bonds and Options	309	(76)
Option Pricing	313	(14)
Background	313	(7)
Black-Scholes Formula	320	(7)
Problems	326	(1)
Option Pricing without Perfect Replication	327	(22)
On the Edges of Arbitrage	327	(2)
One-Period Good-Deal Bounds	329	(7)
Multiple Periods and Continuous Time	336	(9)
Extensions, Other Approaches, and Bibliography	345	(4)
Problems	347	(2)
Term Structure of Interest Rates	349	(36)
Definitions and Notation	349	(6)
Yield Curve and Expectations Hypothesis	355	(2)
Term Structure Models---A Discrete-Time Introduction	357	(5)
Continuous-Time Term Structure Models	362	(6)
Three Linear Term Structure Models	368	(11)
Bibliography and Comments	379	(6)
Problems	382	(3)
Part IV. Empirical Survey	385	(102)
Expected Returns in the Time Series and Cross Section	389	(66)
Time-Series Predictability	391	(44)
The Cross Section: CAPM and Multifactor Models	435	(14)
Summary and Interpretation	449	(6)
Problems	453	(2)
Equity Premium Puzzle and Consumption-Based Models	455	(32)
Equity Premium Puzzles	456	(9)
New Models	465	(16)
Bibliography	481	(6)
Problems	485	(2)
Part V. Appendix	487	(2)
Appendix. Continuous Time	489	(8)
Brownian Motion	489	(2)
Diffusion Model	491	(3)
Ito's Lemma	494	(3)
Problems	495	(2)
References	497	(16)
Author Index	513	(4)
Subject Index	517