Asset Pricing - John H. Cochrane

Part I. Asset pricing theory
14
2   Consumption-based model and overview 15
2.1     Basic pricing equation 15
2.2     Marginal rate of substitution/stochastic discount factor 17
2.3     Prices, payoffs and notation 18
2.4     Intuition, implications, and classic issues in ¿nance 20
3   Discount factors in continuous time 29
3.1     Assumptions and applicability 33
3.2     Consumption-based model in practice 35
3.3    Alternative asset pricing models: Overview 36
4   The discount factor 39
4.1    Contingent claims 39
4.2    Investors again 42
4.3    Risk sharing 44
4.4    State diagram and price function 44
4.5    Law of one price and existence of a discount factor 47
4.6    No-Arbitrage and positive discount factors 53
4.7    Existence in continuous time 57
5   Mean-variance frontier and beta representations 59
5.1     Expected return - Beta representations 59
5.2    Mean-variance frontiers 61
5.3    Relation between s @ H+p{,> beta, and mean-variance frontiers 74
5.4    Testing for priced factors: lambdas or b’s? 87
6   Implications of existence and equivalence theorems 89
6.1     Discount factors vs. mean, variance and beta. 94
7   Conditioning information 97
7.1     Scaled payoffs 98
7.2     Suf¿ciency of adding scaled returns 100
7.3     Conditional and unconditional models 101
7.4     Scaled factors: a partial solution 109
7.5     Summary 111
8   Factor pricing models 112
8.1     Capital Asset Pricing Model (CAPM) 114
8.2     Intertemporal Capital Asset Pricing Model (ICAPM) 124
8.3     Comments on the CAPM and ICAPM 126
8.4     Arbitrage Pricing Theory (APT) 129
8.5     APT vs. ICAPM 139
Part II. Estimating and evaluating asset pricing models 141
9   GMM estimation and testing of asset pricing models 142
9.1     GMM in explicit discount factor models. 142
9.2     Interpreting GMM 145
9.3     Estimating the spectral density matrix 151
10 General formulas, other uses of GMM 157
10.1   General GMM formulas 157
10.2   Standard errors of anything by delta method 159
10.3   Using GMM for regressions 160
10.4   Problems 162
11 GMM variations 163
11.1   Horse Races 163
11.2   Prespeci¿ed weighting matrices 166
11.3   Testing moments 172
11.4   Applying GMM to linear factor models 173
12 Regression-based tests 177
12.1   Time-series regressions 177
12.2   Cross-sectional regressions 182
12.3   Fama-MacBeth Procedure 189
13 Maximum likelihood 196
13.1   Maximum likelihood 196
13.2   When factors are returns, ML prescribes a time-series regression. 198
13.3   When factors are not excess returns, ML prescribes a cross-sectional
regression 201
13.4   Time series vs. cross-section 203
14 ML, GMM and Regression 208
14.1   ML is GMM on the scores 208
14.2   ML approach to a consumption-based model 210
14.3   ML vs. GMM 212
14.4   Problems 220
14.5   References 221
Part III.          General equilbrium and derivative pricing
223
15 General Equilibrium 224
15.1   General Equilibrium Recipe 228
15.2   Endowment economies 228
15.3   Production economies 229
15.4   Justi¿cation for the procedure 229
15.5   Risk sharing and security design. 229
15.6   Incomplete markets economies. 230
15.7   Outlook 230
16 Continuous time and derivative pricing 231
16.1   Diffusion models 231
16.2   Ito’s lemma 234
16.3   Densities 236
16.4   Tricks 237
16.5   Tricks 237
16.6   Black Scholes with discount factors 237
16.7   Arbitrage bounds using discount factors 242
17 “Good-deal” pricing 243
18 Term structure of interest rates 244
18.1   Overview 244
18.2   Models based on a short rate process 244
18.3   Ho-Lee approach 244
18.4   Use to price options 244
19 Frictions 245
Part IV.          Empirical survey
246
20 Return Predictability 247
20.1   Stocks 247
20.2   Term structure 247
20.3   Comparison to continuous-time models 247
20.4   Foreign exchange 247
20.5   Econometric issues 247
20.6   Conditional variance 247
20.7   Conditional Sharpe ratios and portfolio implications 248
21 Present value tests 249
22 Factor pricing models 250
22.1   Capm 250
22.2   Chen Roll Ross model 250
22.3   Investment and macro factors 250
22.4   Book to market 250
22.5   Momentum and more 250
22.6   Digesting the tests 250
23 Consumption based model tests 251
23.1   CRRA utility 251
23.2   Durable goods 251
23.3   Habits 251
23.4   State-nonseparabilities 251
24 Hansen-Jagannathan bounds and equity premium puzzle. 252
24.1   The basic HJ bound and equity premium 253
24.2   Many returns–formulas 254
24.3   Results 264
24.4   Beyond mean and variance. 264
24.5   What do we know about discount factors: a summary 266
24.6   Comments on the Hansen-Jagannathan bound. 266
25 Investment, q and asset pricing 268
Part V. Appendix
269
26 Notation 270
27 Utility functions 274
28 Probability and statistics 275
28.1   Probability 275
28.2   Statistics 279
28.3   Regressions 282
28.4   Partitioned matrix inverse formulas 283
29 Bibliography 285
30 Problems 286