Abstract

http://ssrn.com/abstract=1515624
 
 

Citations



 


 



Information-Based Asset Pricing


Dorje C. Brody


Brunel University - School of Information Systems, Computing and Mathematics

L. P. Hughston


King's College London - Department of Mathematics

Andrea Macrina


affiliation not provided to SSRN


International Journal of Theoretical and Applied Finance, Vol. 11, No. 1, pp. 107-142, 2008

Abstract:     
A new framework for asset price dynamics is introduced in which the concept of noisy information about future cash flows is used to derive the corresponding price processes. In this framework an asset is defined by its cash-flow structure. Each cash flow is modelled by a random variable that can be expressed as a function of a collection of independent random variables called market factors. With each such "X-factor" we associate a market information process, the values of which we assume are accessible to market participants. Each information process consists of a sum of two terms; one contains true information about the value of the associated market factor, and the other represents "noise". The noise term is modelled by an independent Brownian bridge that spans the interval from the present to the time at which the value of the factor is revealed. The market filtration is assumed to be that generated by the aggregate of the independent information processes. The price of an asset is given by the expectation of the discounted cash flows in the risk-neutral measure, conditional on the information provided by the market filtration. In the case where the cash flows are the dividend payments associated with equities, an explicit model is obtained for the share-price process. Dividend growth is taken into account by introducing appropriate structure on the market factors. The prices of options on dividend-paying assets are derived. Remarkably, the resulting formula for the price of a European-style call option is of the Black-Scholes-Merton type. We consider the case where the rate at which information is revealed to the market is constant, and the case where the information rate varies in time. Option pricing formulae are obtained for both cases. The information-based framework generates a natural explanation for the origin of stochastic volatility in financial markets, without the need for specifying on an ad hoc basis the dynamics of the volatility.

Keywords: Asset pricing, partial information, stochastic volatility, correlation, dividend growth, Brownian bridge, nonlinear filtering, market microstructure

Accepted Paper Series


Not Available For Download

Date posted: December 1, 2009  

Suggested Citation

Brody, Dorje C. and Hughston, L. P. and Macrina, Andrea, Information-Based Asset Pricing. International Journal of Theoretical and Applied Finance, Vol. 11, No. 1, pp. 107-142, 2008. Available at SSRN: http://ssrn.com/abstract=1515624

Contact Information

Dorje C. Brody (Contact Author)
Brunel University - School of Information Systems, Computing and Mathematics ( email )
United Kingdom
Lane P. Hughston
King's College London - Department of Mathematics ( email )
London WC2R 2LS
United Kingdom
Andrea Macrina
affiliation not provided to SSRN ( email )
Feedback to SSRN


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