Handbook of the Economics of Finance

by Constantinides; Stulz; Harris

• ISBN13: 9780444513632
• ISBN10: 0444513639
• Format: Hardcover
• Copyright: 2003-11-04
• Publisher: Elsevier Science

Summary

Volume 1B covers the economics of financial markets: the saving and investment decisions; the valuation of equities, derivatives, and fixed income securities; and market microstructure.

Table of Contents

VOLUME 1B
Introduction to the Series	v
Contents of the Handbook	vii
Preface	ix
FINANCIAL MARKETS AND ASSET PRICING
Chapter 10 Arbitrage, State Prices and Portfolio Theory
PHILIP H. DYBVIG and STEPHEN A. ROSS	605	(34)
Abstract	606	(1)
Keywords	606	(1)
1. Introduction	607	(1)
2. Portfolio problems	607	(5)
3. Absence of arbitrage and preference-free results	612	(1)
3.1. Fundamental theorem of asset pricing	614	(1)
3.2. Pricing rule representation theorem	616	(2)
4. Various analyses: Arrow-Debreu world	618	(1)
4.1. Optimal portfolio choice	619	(1)
4.2. Efficient portfolios	619	(1)
4.3. Aggregation	620	(1)
4.4. Asset pricing	621	(1)
4.5. Payoff distribution pricing	622	(2)
5. Capital asset pricing model (CAPM)	624	(5)
6. Mutual fund separation theory	629	(1)
6.1. Preference approach	629	(1)
6.2. Beliefs	631	(2)
7. Arbitrage pricing theory (APT)	633	(1)
8. Conclusion	634	(1)
References	634	(5)
Chapter 11 Intertemporal Asset Pricing Theory
DARRELL DUFFLE	639	(104)
Abstract	641	(1)
Keywords	641	(1)
1. Introduction	642	(1)
2. Basic theory	642	(1)
2.1. Setup	643	(1)
2.2. Arbitrage, state prices, and martingales	644	(1)
2.3. Individual agent optimality	646	(1)
2.4. Habit and recursive utilities	647	(1)
2.5. Equilibrium and Pareto optimality	649	(1)
2.6. Equilibrium asset pricing	651	(1)
2.7. Breeden's consumption-based CAPM	653	(1)
2.8. Arbitrage and martingale measures	654	(1)
2.9. Valuation of redundant securities	656	(1)
2.10. American exercise policies and valuation	657	(4)
3. Continuous-time modeling	661	(1)
3.1. Trading gains for Brownian prices	662	(1)
3.2. Martingale trading gains	663	(1)
3.3. The Black-Scholes option-pricing formula	665	(1)
3.4. Ito's Formula	668	(1)
3.5. Arbitrage modeling	670	(1)
3.6. Numeraire invariance	670	(1)
3.7. State prices and doubling strategies	671	(1)
3.8. Equivalent martingale measures	672	(1)
3.9. Girsanov and market prices of risk	672	(1)
3.10. Black-Scholes again	676	(1)
3.11. Complete markets	677	(1)
3.12. Optimal trading and consumption	678	(1)
3.13. Martingale solution to Merton's problem	682	(4)
4. Term-structure models	686	(1)
4.1. One-factor models	687	(1)
4.2. Term-structure derivatives	691	(1)
4.3. Fundamental solution	693	(1)
4.4. Multifactor term-structure models	695	(1)
4.5. Affine models	696	(1)
4.6. The HJM model of forward rates	699	(3)
5. Derivative pricing	702	(1)
5.1. Forward and futures prices	702	(1)
5.2. Options and stochastic volatility	705	(1)
5.3. Option valuation by transform analysis	708	(3)
6. Corporate securities	711	(1)
6.1. Endogenous default timing	712	(1)
6.2. Example: Brownian dividend growth	713	(1)
6.3. Taxes, bankruptcy costs, capital structure	717	(1)
6.4. Intensity-based modeling of default	719	(1)
6.5. Zero-recovery bond pricing	721	(1)
6.6. Pricing with recovery at default	722	(1)
6.7. Default-adjusted short rate	724	(1)
References	725	(18)
Chapter 12 Tests of Multifactor Pricing Models, Volatility Bounds and Portfolio Performance
WAYNE E. FERSON	743	(60)
Abstract	745	(1)
Keywords	745	(1)
1. Introduction	746	(2)
2. Multifactor asset-pricing models: Review and integration	748	(1)
2.1. The stochastic discount factor representation	748	(1)
2.2. Expected risk premiums	750	(1)
2.3. Return predictability	751	(1)
2.4. Consumption-based asset-pricing models	753	(1)
2.5. Multi-beta pricing models	754	(1)
2.6. Mean-variance efficiency with conditioning information	760	(1)
2.7. Choosing the factors	765	(3)
3. Modern variance bounds	768	(1)
3.1. The Hansen-Jagannathan bounds	768	(1)
3.2. Variance bounds with conditioning information	770	(1)
3.3. The Hansen-Jagannathan distance	773	(1)
4. Methodology and tests of multifactor asset-pricing models	774	(1)
4.1. The Generalized Method of Moments approach	774	(1)
4.2. Cross-sectional regression methods	775	(1)
4.3. Multivariate regression and beta-pricing models	781	(4)
5. Conditional performance evaluation	785	(1)
5.1. Stochastic discount factor formulation	787	(1)
5.2. Beta-pricing formulation	788	(1)
5.3. Using portfolio weights	790	(1)
5.4. Conditional market-timing models	792	(1)
5.5. Empirical evidence on conditional performance	793	(1)
6. Conclusions	794	(1)
References	795	(8)
Chapter 13 Consumption-Based Asset Pricing
JOHN Y CAMPBELL	803	(86)
Abstract	804	(1)
Keywords	804	(1)
1. Introduction	805	(5)
2. International stock market data	810	(6)
3. The equity premium puzzle	816	(1)
3.1. The stochastic discount factor	816	(1)
3.2. Consumption-based asset pricing with power utility	819	(1)
3.3. The risk-free rate puzzle	824	(1)
3.4. Bond returns and the equity-premium and risk-free rate puzzles	827	(1)
3.5. Separating risk aversion and intertemporal substitution	828	(4)
4. The dynamics of asset returns and consumption	832	(1)
4.1. Time-variation in conditional expectations	832	(1)
4.2. A loglinear asset-pricing framework	836	(1)
4.3. The equity volatility puzzle	840	(1)
4.4. Implications for the equity premium puzzle	845	(1)
4.5. What does the stock market forecast?	849	(1)
4.6. Changing volatility in stock returns	857	(1)
4.7. What does the bond market forecast?	859	(7)
5. Cyclical variation in the price of risk	866	(1)
5.1. Habit formation	866	(1)
5.2. Models with heterogeneous agents	873	(1)
5.3. Irrational expectations	876	(3)
6. Some implications for macroeconomics	879	(2)
References	881	(8)
Chapter 14 The Equity Premium in Retrospect
RAINISH MEHRA and EDWARD C. PRESCOTT	889	(50)
Abstract	890	(1)
Keywords	890	(1)
1. Introduction	891	(1)
2. The equity premium: history	891	(1)
2.1. Facts	891	(1)
2.2. Data sources	892	(1)
2.3. Estimates of the equity premium	894	(1)
2.4. Variation in the equity premium over time	897	(2)
3. Is the equity premium due to a premium for bearing non-diversifiable risk?	899	(1)
3.1. Standard preferences	902	(1)
3.2. Estimating the equity risk premium versus estimating the risk aversion parameter	912	(1)
3.3. Alternative preference structures	913	(1)
3.4. Idiosyncratic and uninsurable income risk	918	(1)
3.5. Models incorporating a disaster state and survivorship bias	920	(1)
4. Is the equity premium due to borrowing constraints, a liquidity premium or taxes?	921	(1)
4.1. Borrowing constraints	921	(1)
4.2. Liquidity premium	924	(1)
4.3. Taxes and regulation	924	(3)
5. An equity premium in the future?	927	(1)
Appendix A	928	(2)
Appendix B. The original analysis of the equity premium puzzle	930	(1)
B.1. The economy, asset prices and returns	930	(5)
References	935	(4)
Chapter 15 Anomalies and Market Efficiency
G. WILLIAM SCHWERT	939	(36)
Abstract	941	(1)
Keywords	941	(1)
1. Introduction	942	(1)
2. Selected empirical regularities	943	(1)
2.1. Predictable differences in returns across assets	943	(1)
2.2. Predictable differences in returns through time	951	(5)
3. Returns to different types of investors	956	(1)
3.1. Individual investors	956	(1)
3.2. Institutional investors	958	(1)
3.3. Limits to arbitrage	961	(1)
4. Long-run returns	961	(1)
4.1. Returns to firms issuing equity	962	(1)
4.2. Returns to bidder firms	964	(2)
5. Implications for asset pricing	966	(1)
5.1. The search for risk factors	966	(1)
5.2. Conditional asset pricing	967	(1)
5.3. Excess volatility	967	(1)
5.4. The role of behavioral finance	967	(1)
6. Implications for corporate finance	968	(1)
6.1. Firm size and liquidity	968	(1)
6.2. Book-to-market effects	968	(1)
6.3. Slow reaction to corporate financial policy	969	(1)
7. Conclusions	970	(1)
References	970	(5)
Chapter 16 Are Financial Assets Priced Locally or Globally?
G. ANDREW KAROLYI and RENE M. STULI	975	(46)
Abstract	976	(1)
Keywords	976	(1)
1. Introduction	977	(1)
2. The perfect financial markets model	978	(1)
2.1. Identical consumption-opportunity sets across countries	979	(1)
2.2. Different consumption-opportunity sets across countries	982	(1)
2.3. A general approach	988	(1)
2.4. Empirical evidence on asset pricing using perfect market models	992	(5)
3. Home bias	997	(7)
4. Flows, spillovers, and contagion	1004	(1)
4.1. Flows and returns	1007	(1)
4.2. Correlations, spillovers, and contagion	1010	(4)
5. Conclusion	1014	(1)
References	1014	(7)
Chapter 17 Microstructure and Asset Pricing
DAVID EASLEY and MAUREEN O'HARA	1021	(32)
Abstract	1022	(1)
Keywords	1022	(1)
1. Introduction	1023	(1)
2. Equilibrium asset pricing	1024	(1)
3. Asset pricing in the short-run	1025	(1)
3.1. The mechanics of pricing behavior	1026	(1)
3.2. The adjustment of prices to information	1029	(1)
3.3. Statistical and structural models of microstructure data	1031	(1)
3.4. Volume and price movements	1033	(2)
4. Asset pricing in the long-run	1035	(1)
4.1. Liquidity	1036	(1)
4.2. Information	1041	(3)
5. Linking microstructure and asset pricing: puzzles for researchers	1044	(3)
References	1047	(6)
Chapter 18 A Survey of Behavioral Finance
NICHOLAS BARBERIS and RICHARD THALER	1053	(72)
Abstract	1054	(1)
Keywords	1054	(1)
1. Introduction	1055	(1)
2. Limits to arbitrage	1056	(1)
2.1. Market efficiency	1056	(1)
2.2. Theory	1058	(1)
2.3. Evidence	1061	(4)
3. Psychology	1065	(1)
3.1. Beliefs	1065	(1)
3.2. Preferences	1069	(6)
4. Application: The aggregate stock market	1075	(1)
4.1. The equity premium puzzle	1078	(1)
4.2. The volatility puzzle	1083	(4)
5. Application: The cross-section of average returns	1087	(1)
5.1. Belief based models	1092	(1)
5.2. Belief based models with institutional frictions	1095	(1)
5.3. Preferences	1097	(1)
6. Application: Closed-end funds and comovement	1098	(1)
6.1. Closed-end funds	1098	(1)
6.2. Comovement	1099	(2)
7. Application: Investor behavior	1101	(1)
7.1. Insufficient diversification	1101	(1)
7.2. Naive diversification	1103	(1)
7.3. Excessive trading	1103	(1)
7.4. The selling decision	1104	(1)
7.5. The buying decision	1105	(1)
8. Application: Corporate finance	1106	(1)
8.1. Security issuance, capital structure and investment	1106	(1)
8.2. Dividends	1109	(1)
8.3. Models of managerial irrationality	1111	(2)
9. Conclusion	1113	(2)
Appendix A	1115	(1)
References	1116	(9)
Finance, Optimization, and the Irreducibly Irrational Component of Human Behavior
ROBERT J. SHILLER	1125	(4)
Chapter 19 Derivatives
ROBERT E. WHALEY	1129	(78)
Abstract	1131	(1)
Keywords	1131	(1)
1. Introduction	1132	(1)
2. Background	1133	(6)
3. No-arbitrage pricing relations	1139	(1)
3.1. Carrying costs	1140	(1)
3.2. Valuing forward/futures using the no-arbitrage principle	1141	(1)
3.3. Valuing options using the no-arbitrage principle	1143	(5)
4. Option valuation	1148	(1)
4.1. The Black-Scholes/Merton option valuation theory	1149	(1)
4.2. Analytical formulas	1151	(1)
4.3. Approximation methods	1157	(1)
4.4. Generalizations	1164	(2)
5. Studies of no-arbitrage price relations	1166	(1)
5.1. Forward/futures prices	1167	(1)
5.2. Option prices	1169	(1)
5.3. Summary and analysis	1173	(1)
6. Studies of option valuation models	1173	(1)
6.1. Pricing errors/implied volatility anomalies	1174	(1)
6.2. Trading simulations	1176	(1)
6.3. Informational content of implied volatility	1179	(1)
6.4. Summary and analysis	1181	(8)
7. Social costs/benefits of derivatives trading	1189	(1)
7.1. Contract introductions	1189	(1)
7.2. Contract expirations	1193	(1)
7.3. Market synchronization	1194	(1)
7.4. Summary and analysis	1197	(1)
8. Summary	1198	(1)
References	1199	(8)
Chapter 20 Fixed-Income Pricing
QIANG DAI and KENNETH J. SINGLETON	1207
Abstract	1208	(1)
Keywords	1208	(1)
1. Introduction	1209	(1)
2. Fixed-income pricing in a diffusion setting	1210	(1)
2.1. The term structure	1210	(1)
2.2. Fixed-income securities with deterministic payoffs	1211	(1)
2.3. Fixed-income securities with state-dependent payoffs	1212	(1)
2.4. Fixed-income securities with stopping times	1213	(2)
3. Dynamic term-structure models for default-free bonds	1215	(1)
3.1. One-factor dynamic term-structure models	1215	(1)
3.2. Multi-factor dynamic term-structure models	1218	(4)
4. Dynamic term-structure models with jump diffusions	1222	(1)
5. Dynamic term-structure models with regime shifts	1223	(2)
6. Dynamic term-structure models with rating migrations	1225	(1)
6.1. Fractional recovery of market value	1225	(1)
6.2. Fractional recovery of par, payable at maturity	1228	(1)
6.3. Fractional recovery of par, payable at default	1229	(1)
6.4. Pricing defaultable coupon bonds	1229	(1)
6.5. Pricing Eurodollar swaps	1230	(1)
7. Pricing of fixed-income derivatives	1231	(1)
7.1. Derivatives pricing using dynamic term-structure models	1231	(1)
7.2. Derivatives pricing using forward-rate models	1232	(1)
7.3. Defaultable forward-rate models with rating migrations	1234	(1)
7.4. The LIBOR market model	1237	(1)
7.5. The swaption market model	1241	(1)
References	1242
Subject Index	I-1