Asset Pricing under Information with Stochastic Volatility

Abstract

Based on a general specification of the asset specific pricing kernel, we develop a pricing model using an information process with stochastic volatility. We derive analytical asset and option pricing formulas. The asset prices in this rational expectations model exhibit crash-like, strong downward movements. The resulting option pricing formula is consistent with the strong negative skewness and high levels of kurtosis observed in empirical studies. Furthermore, we determine credit spreads in a simple structural model.

Keywords: Pricing kernel, stochastic volatility, asset pricing, option pricing, credit spreads

JEL Classification: G12, G13