The Econometrics of Financial Markets

by Campbell, John W.

• ISBN13: 9780691043012
• ISBN10: 0691043019
• Format: Hardcover
• Copyright: 1996-12-09
• Publisher: Princeton Univ Pr

Summary

The past twenty years have seen an extraordinary growth in the use of quantitative methods in financial markets. Finance professionals now routinely use sophisticated statistical techniques in portfolio management, proprietary trading, risk management, financial consulting, and securities regulation. This graduate-level textbook is intended for PhD students, advanced MBA students, and industry professionals interested in the econometrics of financial modeling. The book covers the entire spectrum of empirical finance, including: the predictability of asset returns, tests of the Random Walk Hypothesis, the microstructure of securities markets, event analysis, the Capital Asset Pricing Model and the Arbitrage Pricing Theory, the term structure of interest rates, dynamic models of economic equilibrium, and nonlinear financial models such as ARCH, neural networks, statistical fractals, and chaos theory. Each chapter develops statistical techniques within the context of a particular financial application. This exciting new text contains a unique and accessible combination of theory and practice, bringing state-of-the-art statistical techniques to the forefront of financial applications. Each chapter also includes a discussion of recent empirical evidence, for example, the rejection of the Random Walk Hypothesis, as well as problems designed to help readers incorporate what they have read into their own applications. Professors: A supplementary Solutions Manual is available for this book. It is restricted to teachers using the text in courses. For information on how to obtain a copy, refer to: http://pup.princeton.edu/solutions.html

Table of Contents

List of Figures	xiii
List of Tables	xv
Preface	xvii
Introduction	3	(24)
Organization of the Book	4	(2)
Useful Background	6	(2)
Mathematics Background	6	(1)
Probability and Statistics Background	6	(1)
Finance Theory Background	7	(1)
Notation	8	(1)
Prices, Returns, and Compounding	9	(11)
Definitions and Conventions	9	(4)
The Marginal, Conditional, and Joint Distribution of Returns	13	(7)
Market Efficiency	20	(7)
Efficient Markets and the Law of Iterated Expectations	22	(2)
Is Market Efficiency Testable?	24	(3)
The Predictability of Asset Returns	27	(56)
The Random Walk Hypotheses	28	(5)
The Random Walk 1: IID Increments	31	(1)
The Random Walk 2: Independent Increments	32	(1)
The Random Walk 3: Uncorrelated Increments	33	(1)
Tests of Random Walk 1: IID Increments	33	(8)
Traditional Statistical Tests	33	(1)
Sequences and Reversals, and Runs	34	(7)
Tests of Random Walk 2: Independent Increments	41	(3)
Filter Rules	42	(1)
Technical Analysis	43	(1)
Tests of Random Walk 3: Uncorrelated Increments	44	(11)
Autocorrelation Coefficients	44	(3)
Portmanteau Statistics	47	(1)
Variance Ratios	48	(7)
Long Horizon Returns	55	(4)
Problems with Long-Horizon Inferences	57	(2)
Tests For Long-Range Dependence	59	(5)
Examples of Long-Range Dependence	59	(3)
The Hurst-Mandelbrot Rescaled Range Statistic	62	(2)
Unit Root Tests	64	(1)
Recent Empirical Evidence	65	(15)
Autocorretations	66	(2)
Variance Ratios	68	(6)
Cross-Autocorrelations and Lead-Lag Relations	74	(4)
Tests Using Long-Horizon Returns	78	(2)
Conclusion	80	(3)
Market Microstructure	83	(66)
Nonsynchronous Trading	84	(15)
A Model of Nonsynchronous Trading	85	(13)
Extensions and Generalizations	98	(1)
The Bid-Ask Spread	99	(8)
Bid-Ask Bounce	101	(2)
Components of the Bid-Ask Spread	103	(4)
Modeling Transactions Data	107	(21)
Motivation	108	(6)
Rounding and Barrier Models	114	(8)
The Ordered Probit Model	122	(6)
Recent Empirical Findings	128	(16)
Nonsynchronous Trading	128	(6)
Estimating the Effective Bid-Ask Spread	134	(2)
Transactions Data	136	(8)
Conclusion	144	(5)
Event-Study Analysis	149	(32)
Outline of an Event Study	150	(2)
An Example of an Event Study	152	(1)
Models for Measuring Normal Performance	153	(4)
Constant-Mean-Return Model	154	(1)
Market Model	155	(1)
Other Statistical Models	155	(1)
Economic Models	156	(1)
Measuring and Analyzing Abnormal Returns	157	(10)
Estimation of the Market Model	158	(1)
Statistical Properties of Abnormal Returns	159	(1)
Aggregation of Abnormal Returns	160	(2)
Sensitivity to Normal Return Model	162	(1)
CARs for the Earnings-Announcement Example	163	(3)
Inferences with Clustering	166	(1)
Modifying the Null Hypothesis	167	(1)
Analysis of Power	168	(4)
Nonparametric Tests	172	(1)
Cross-Sectional Models	173	(2)
Further Issues	175	(3)
Role of the Sampling Interval	175	(1)
Inferences with Event-Date Uncertainty	176	(1)
Possible Biases	177	(1)
Conclusion	178	(3)
Capital Asset Pricing Model	181	(38)
Review of the CAPM	181	(3)
Results from Efficient-Set Mathematics	184	(4)
Statistical Framework for Estimation and Testing	188	(15)
Sharpe-Lintner Version	189	(7)
Black Version	196	(7)
Size of Tests	203	(1)
Power of Tests	204	(4)
Nonnormal and Non-IID Returns	208	(3)
Implementation of Tests	211	(4)
Summary of Empirical Evidence	211	(1)
Illustrative Implementation	212	(1)
Unobservability of the Market Portfolio	213	(2)
Cross-Sectional Regressions	215	(2)
Conclusion	217	(2)
Multifactor Pricing Models	219	(34)
Theoretical Background	219	(3)
Estimation and Testing	222	(9)
Portfolios as Factors with a Riskfree Asset	223	(1)
Portfolios as Factors without a Riskfree Asset	224	(2)
Macroeconomic Variables as Factors	226	(2)
Factor Portfolios Spanning the Mean-Variance Frontier	228	(3)
Estimation of Risk Premia and Expected Returns	231	(2)
Selection of Factors	233	(7)
Statistical Approaches	233	(5)
Number of Factors	238	(1)
Theoretical Approaches	239	(1)
Empirical Results	240	(2)
Interpreting Deviations from Exact Factor Pricing	242	(9)
Exact Factor Pricing Models, Mean-Variance Analysis, and the Optimal Orthogonal Portfolio	243	(2)
Squared Sharpe Ratios	245	(1)
Implications for Separating Alternative Theories	246	(5)
Conclusion	251	(2)
Present Value Relations	253	(38)
The Relation between Prices, Dividends, and Returns	254	(13)
The Linear Present Value Relation with Constant Expected Returns	255	(3)
Rational Bubbles	258	(2)
An Approximate Present-Value Relation with Time-Varying Expected Returns	260	(4)
Prices and Returns in a Simple Example	264	(3)
Present Value Relations and US Stock Price Behavior	267	(19)
Long-Horizon Regressions	267	(8)
Volatility Tests	275	(4)
Vector Autoregressive Methods	279	(7)
Conclusion	286	(5)
Intertemporal Equilibrium Models	291	(48)
The Stochastic Discount Factor	293	(11)
Volatility Bounds	296	(8)
Consumption-Based Asset Pricing with Power Utility	304	(10)
Power Utility in a Lognormal Model	306	(8)
Power Utility and Generalized Method of Moments	314	(1)
Market Frictions	314	(12)
Market Frictions and Hansen-Jagannathan Bounds	315	(1)
Market Frictions and Aggregate Consumption Data	316	(10)
More General Utility Functions	326	(8)
Habit Formation	326	(6)
Psychological Models of Preferences	332	(2)
Conclusion	334	(5)
Derivative pricing Models	339	(56)
Brownian Motion	341	(8)
Constructing Brownian Motion	341	(5)
Stochastic Differential Equations	346	(3)
A Brief Review of Derivative Pricing Methods	349	(6)
The Black-Scholes and Merton Approach	350	(4)
The Martingale Approach	354	(1)
Implementing Parametric Option Pricing Models	355	(27)
Parameter Estimation of Asset Price Dynamics	356	(5)
Estimating Q in the Black-Scholes Model	361	(6)
Quantifying the Precision of Option Price Estimators	367	(2)
The Effects of Asset Return Predictability	369	(8)
Implied Volatility Estimators	377	(2)
Stochastic Volatility Models	379	(3)
Pricing Path-Dependent Derivatives Via Monte Carlo Simulation	382	(9)
Discrete Versus Continuous Time	383	(1)
How Many Simulations to Perform	384	(1)
Comparisons with a Closed-Form Solution	384	(2)
Computational Efficiency	386	(4)
Extensions and Limitations	390	(1)
Conclusion	391	(4)
Fixed-Income Securities	395	(32)
Basic Concepts	396	(17)
Discount Bonds	397	(4)
Coupon Bonds	401	(8)
Estimating the Zero-Coupon Term Structure	409	(4)
Interpreting the Term Structure of Interest Rates	413	(10)
The Expectations Hypothesis	413	(5)
Yield Spreads and Interest Rate Forecasts	418	(5)
Conclusion	423	(4)
Term-Structure Models	427	(40)
Affine-Yield Models	428	(14)
A Homoskedastic Single-Factor Model	429	(6)
A Square-Root Single-Factor Model	435	(3)
A Two-Factor Model	438	(3)
Beyond Affine-Yield Models	441	(1)
Fitting Term-Structure Models to the Data	442	(13)
Real Bonds, Nominal Bonds, and Inflation	442	(3)
Empirical Evidence on Affine-Yield Models	445	(10)
Pricing Fixed-Income Derivative Securities	455	(9)
Fitting the Current Term Structure Exactly	456	(2)
Forwards and Futures	458	(3)
Option Pricing in a Term-Structure Model	461	(3)
Conclusion	464	(3)
Nonlinearities in Financial Data	467	(60)
Nonlinear Structure in Univariate Time Series	468	(11)
Some Parametric Models	470	(5)
Univariate Tests for Nonlinear Structure	475	(4)
Models of Changing Volatility	479	(15)
Univariate Models	481	(9)
Multivariate Models	490	(4)
Links between First and Second Moments	494	(1)
Nonparametric Estimation	494	(18)
Kernel Regression	500	(2)
Optimal Bandwidth Selection	502	(2)
Average Derivative Estimators	504	(3)
Application: Estimating State-Price Densities	507	(5)
Artificial Neural Networks	512	(11)
Multilayer Perceptrons	512	(4)
Radial Basis Functions	516	(2)
Projection Pursuit Regression	518	(1)
Limitations of Learning Networks	518	(1)
Application: Learning the Black-Scholes Formula	519	(4)
Overfitting and Data-Snooping	523	(1)
Conclusion	524	(3)
Appendix	527	(14)
A.1 Linear Instrumental Variables	527	(5)
A.2 Generalized Method of Moments	532	(2)
A.3 Serially Correlated and Heteroskedastic Errors	534	(2)
A.4 GMM and Maximum Likelihood	536	(5)
References	541	(46)
Author Index	587	(10)
Subject Index	597