This paper investigates parametric pricing kernels for interest rate options within the intertemporal CAPM framework. The usual GMM estimation produces problematic pricing kernels that either fail statistical robustness tests or are inconsistent with economic theory in terms of being hump-shaped and having negative segments. Adopting the second Hansen-Jagannathan (HJ) distance, the four-term po...

In this paper we study a binomial model with random time steps and explain how to calculate values for European and American call and put options. We prove both weak convergence of the discrete processes to the Black}Scholes setup and convergence of the values for European and American put options. Computational experiments exhibit a smooth convergence structure and suggest that we can obtain a...

This paper derives a preemptive equilibrium in strategic investment in alternative projects. The problem is formulated in a real options model with a multidimensional state variable that represents project-specific uncertainty. The proposed method enables us to evaluate the value of potential alternatives. The results not only extend previous studies with a one-dimensional state variable but al...

Paralleling regulatory developments, we devise value-at-risk and expected shortfall type risk measures for the potential losses arising from using misspecified models when pricing and hedging contingent claims. Essentially, losses from model risk correspond to losses realized on a perfectly hedged position. Model uncertainty is expressed by a set of pricing models, relative to which potential l...

where g1(x) = εg11(x)+ε g12(x)+ε g13(x), g2(x) = εg21(x) + ε g22(x) + ε g23(x) and f(x) = εf1(x) + εf2(x) + ε f3(x) where g1i, g2i, f2i have degree k, m and n respectively for each i = 1, 2, 3, and ε is a small parameter. Note that when g1(x) = 0 we obtain the generalized Liénard polynomial differential systems. We provide an upper bound of the maximum number of limit cycles that the previous d...

This article develops a real options model to study the interaction of industry structure and takeovers. In an asymmetric industry equilibrium, firms have an endogenous incentive to merge when restructuring decisions are motivated by operating and strategic benefits. The model predicts that (i) merger activities are more likely in more concentrated industries or in industries that are more expo...

This paper investigates the effects of mortgage-backed securities (MBS) hedging activity on interest-rate volatility and proposes a model that takes these effects into account. An empirical examination suggests that the inclusion of information about MBS considerably improves model performance in pricing interest-rate options and in forecasting future interest-rate volatility. The empirical res...

We analyze oligopolistic exhaustible-resource depletion when firms can trade forward contracts on deliveries, a market structure prevalent in most resource commodity markets. When market interactions become arbitrarily frequent, all stocks are contracted and subgame-perfect equilibrium allocation becomes perfectly competitive. The result is in contrast with the idea that forward markets can hel...

Using sovereign CDS spreads and currency option data for Mexico and Brazil, we document that CDS spreads covary with both the currency option implied volatility and the slope of the implied volatility curve in moneyness. We propose a joint valuation framework, in which currency return variance and sovereign default intensity follow a bivariate diffusion with contemporaneous correlation. Estimat...

In this article, we investigate the valuation of insurance derivatives which facilitate the trading of insurance risks on capital markets, such as catastrophe derivatives that were traded at the Chicago Board of Trade. These instruments have to be priced relative to observed insurance premiums that are written on the same underlying risks to exclude any arbitrage opportunities. We derive a repr...