Macrina, A;
Parbhoo, PA;
(2014)
Randomised mixture models for pricing kernels.
Asia-Pacific Financial Markets
, 2
(4)
pp. 281-315.
10.1007/s10690-014-9186-7.
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Abstract
Numerous kinds of uncertainties may affect an economy, e.g. economic, political, and en- vironmental ones. We model the aggregate impact by the uncertainties on an economy and its associated financial market by randomised mixtures of Lévy processes. We assume that mar- ket participants observe the randomised mixtures only through best estimates based on noisy market information. The concept of incomplete information introduces an element of stochastic filtering theory in constructing what we term “filtered Esscher martingales”. We make use of this family of martingales to develop pricing kernel models. Examples of bond price models are examined, and we show that the choice of the random mixture has a significant effect on the model dynamics and the types of movements observed in the associated yield curves. Parameter sensitivity is analysed and option price processes are derived. We extend the class of pricing kernel models by considering a weighted heat kernel approach, and develop models driven by mixtures of Markov processes.
| Type: | Article |
|---|---|
| Title: | Randomised mixture models for pricing kernels |
| Open access status: | An open access version is available from UCL Discovery |
| DOI: | 10.1007/s10690-014-9186-7 |
| Publisher version: | http://dx.doi.org/10.1007/s10690-014-9186-7 |
| Language: | English |
| Additional information: | This article is distributed under the terms of the Creative Commons Attribution License which permits any use, distribution, and reproduction in any medium, provided the original author(s) and the source are credited. |
| Keywords: | Pricing kernel, asset pricing, interest rates, yield curve, randomised mixtures, Lévy processes, Esscher martingales, weighted heat kernel, Markov processes |
| UCL classification: | UCL UCL > Provost and Vice Provost Offices UCL > Provost and Vice Provost Offices > UCL BEAMS UCL > Provost and Vice Provost Offices > UCL BEAMS > Faculty of Maths and Physical Sciences UCL > Provost and Vice Provost Offices > UCL BEAMS > Faculty of Maths and Physical Sciences > Dept of Mathematics |
| URI: | https://discovery.ucl.ac.uk/id/eprint/1376524 |
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