Asset Pricing Approach Research Articles

Risk Appetite and Exchange Rates

We present evidence that fluctuations in the aggregate balance sheets of financial intermediaries forecast exchange rate returns—at weekly, monthly, and quarterly frequencies, both in and out of sample, and for a large set of countries. We estimate prices of risk using a cross-sectional, arbitrage-free asset pricing approach and show that balance sheets forecast exchange rates because of the latter’s association with fluctuations in risk premia. We provide a rationale for an intertemporal equilibrium pricing theory in which intermediaries are subject to balance sheet constraints.

A General-Equilibrium Asset-Pricing Approach to the Measurement of Nominal and Real Bank Output

This paper addresses the proper measurement of financial service output that is not priced explicitly. It shows how to impute nominal service output from financial intermediaries' interest income, and how to construct price indices for those financial services. We model financial intermediaries as providers of financial services which resolve asymmetric information between borrowers and lenders. We embed these intermediaries in a dynamic, stochastic, general-equilibrium model where assets are priced competitively according to their systematic risk, as in the standard consumption-based capital-asset-pricing model. In this environment, we show that it is critical to take risk into account in order to measure financial output accurately. We also show that even using a risk-adjusted rate does not solve all the problems associated with measuring nominal financial service output. Our model allows us to address important outstanding questions in output and productivity measurement for financial firms, such as: (1) What are the correct reference to use in calculating bank output? In particular, should they take account of risk? (2) If rates need to be risk-adjusted, should they be ex ante or ex post rates of return? (3) What is the right price deflator for the output of financial firms? Is it just the general price index? (4) When--if ever--should we count capital gains of financial firms as part of financial service output?

Evidence on the Tradeoff Between Risk and Return for Ipo and Seo Firms

Do the low long-run average returns of equity issuers reflect Do the low long-run average returns of equity issuers reflect underperformance due to mispricing or the risk characteristics of the issuing firms? We shed new light on this question by examining how institutional lenders price loans of equity-issuing firms. We find that equity-issuing firms' expected debt return is equivalent to the expected debt return of non-issuing firms with similar characteristics, implying that institutional lenders perceive equity issuers to be as risky as similar non-issuing firms. We also find that institutional lenders perceive small and high book-to-market borrowers as systematically riskier than larger borrowers with low book-to-market ratios, consistent with the asset pricing approach in Fama and French (1993). Finally, we find that firms' expected debt returns decline after equity offerings, consistent with recent theoretical arguments suggesting that firm risk should decline following an equity offering if equity is issued to exercise a real option. Overall, our analysis provides novel evidence consistent with risk-based explanations for the observed equity returns following IPOs and SEOs.

House prices and rents: An equilibrium asset pricing approach

Abstract We use a relatively general intertemporal asset pricing model where housing services and consumption are non-separable to measure overvaluation of housing in relation to rents in Spain, the UK and the US. Part of the increase in real house prices during the late nineties can be seen as a return to equilibrium following some undershooting after previous price peaks. However, marked increases in house prices led to price-to-rent ratios above equilibrium by mid-2003 (around 30% above equilibrium in the UK, 20% in Spain and 10% in the US). Part of that overvaluation — particularly in Spain and the UK — may be attributable to the sluggishness of supply in the presence of large demand shocks in this market and/or the slow adjustment of observed rents.

GSE Funding Advantages and Mortgagor Benefits: Answers from Asset Pricing

We take an asset pricing approach to model the funding advantage of Government Sponsored Enterprises (GSEs) such as Fannie Mae and Freddie Mac. In order to replicate some stylized facts, we extend a referenced model to incorporate defaultability of mortgage agencies. The model implies that the direct effect from having a government guarantee results in a funding advantage of 21 bp. This indicates that the funding advantage of 40 bps estimated in the literature may be a bad proxy for the dollar value of the liability to the government. For a GSE, which explicitly takes a guarantee into account, the funding advantage is passed through to mortgagors. If not, as much as 75% of the funding advantage is retained by the GSE. We relate this to empirical findings in the earlier literature. Finally, we discuss and illustrate how a government guarantee in itself can induce a stabilized mortgage market.

Idiosyncratic Risk and Returns in International Equity Markets

The traditional mean-variance asset pricing approach posits that in equilibrium only market risk matters. This study finds counterevidence in international equity markets. Specifically, this paper shows that average idiosyncratic volatility predicts world premium. Marginal investors appear to endure idiosyncratic risk, view idiosyncratic risk as a relevant component of risk, and demand a risk premium for bearing the risk. This study then extends the analysis to individual national markets. The results show that a large number of national markets have significant exposures to the mimicking portfolio of individual idiosyncratic volatility. The distribution of the exposures suggests that location may play an important role in pricing idiosyncratic risk.

Estimates of the Term Premium on Near-dated Federal Funds Futures Contracts

This paper examines estimates of the term premium on federal funds futures rates, with a focus on near-dated contracts and therefore the more immediate policy horizon. The first set of methods assumes that the term premium is constant over time. Under this framework, calculations that use survey data to proxy for forecast errors produce more intuitive results than estimates based on the restrictive assumption that forecast errors average to zero over the sample. The second set of methods allows the term premium to vary over time, but the results based on the term structure of near-dated federal funds futures contracts are highly volatile, which perhaps reflects numerous technical factors in the underlying federal funds market. Finally, under an asset-pricing approach, the CAPM suggests that the risk premium on federal funds futures is either less than or equal to zero, while APT indicates that it can be positive.

The Optimal Mix of Bank and Market Debt: An Asset Pricing Approach

This paper examines the optimal mix and priority structure of bank and market debt using a tax shield-bankruptcy cost tradeoff model where the only unique feature of banks is their ability to renegotiate. Closed-form expressions are derived for the values of renegotiable bank debt, non-renegotiable market debt, equity, and levered firm values. Optimal debt structure hinges upon the division of ex post bargaining power between the firm and bank. Weak firms utilize bank debt exclusively. Strong firms use a mixture of bank and market debt, with bank debt senior. The model explains: (i) why small firms use bank debt exclusively; (ii) why large firms employ mixed debt financing; (iii) why bank debt is senior; and (iv) why firms shift from bank debt into a mixture of market and bank debt over their life-cycle. Optimal debt contracts entail Absolute Priority, and we provide estimates of the cost of ex post priority violations across creditor classes.

Estimates of the Term Premium on Near-dated Federal Funds Futures Contracts

This paper examines estimates of the term premium on federal funds futures rates, with a focus on near-dated contracts and therefore the more immediate policy horizon. The first set of methods assumes that the term premium is constant over time. Under this framework, calculations that use survey data to proxy for forecast errors produce more intuitive results than estimates based on the restrictive assumption that forecast errors average to zero over the sample. The second set of methods allows the term premium to vary over time, but the results based on the term structure of near-dated federal funds futures contracts are highly volatile, which perhaps reflects numerous technical factors in the underlying federal funds market. Finally, under an asset-pricing approach, the CAPM suggests that the risk premium on federal funds futures is either less than or equal to zero, while APT indicates that it can be positive.

Valuing a Multi-Zone Mine as a Real Asset Portfolio - A Modern Asset Pricing (Real Options) Approach

Modern asset pricing (MAP; commonly known as real options valuation) has been used as an alternative to discounted cash flow (DCF) methods in the mining industry to improve the representation of project structure within project valuation models. Previous mining applications of MAP have tended to treat the ore deposit as a homogenous entity as opposed to a heterogenous one in which the deposit can be subdivided into zones differentiated by size, quality and location. This is an inadequate approach for some mining applications because management may implement operating strategies that capitalize on geological structure such as selective zone closure in response to low mineral prices. This paper introduces a project structure model that reflects the heterogenous nature of mineral deposits by representing the project as a real asset portfolio in which each zone represents a portfolio asset. The project is operated in discrete intervals by choosing, at the start of each interval, an operating mode from a set of competing operating modes. Each mode specifies the combinations of zones that will be active and the amount of project capacity that is built, abandoned or temporarily closed. A two-zone mining example is used to demonstrate the proposed model and show how operating strategies that capitalize on geological structure can add value.

223024 (M30) Personal automobile premiums: An asset share pricing approach for property/casualty insurance : Sholom Feldblum S.,Casualty Actuarial Society, Proceedings, Volume LXXXIII, Part 2, Nr. 159, 1996, pp 190–298

223024 (M30) Personal automobile premiums: An asset share pricing approach for property/casualty insurance : Sholom Feldblum S.,Casualty Actuarial Society, Proceedings, Volume LXXXIII, Part 2, Nr. 159, 1996, pp 190–298