Detecting Money Market Bubbles

33 Pages Posted: 17 Oct 2016

See all articles by Jan F. Baldeaux

Jan F. Baldeaux

Standard Chartered Bank

Katja Ignatieva

University of New South Wales (UNSW); University of New South Wales - Australian School of Business

Eckhard Platen

University of Technology, Sydney (UTS) - Finance Discipline Group; University of Technology Sydney, School of Mathematical and Physical Sciences; Financial Research Network (FIRN)

Date Written: October 17, 2016

Abstract

Using a range of stochastic volatility models well-known in the nance literature, we study the existence of money market bubbles in the US economy. Money market bubbles preclude the existence of a risk-neutral pricing measure. Understanding whether markets exhibit money market bubbles is crucial from the point of view of derivative pricing since their existence implies the existence of a self-financing trading strategy that replicates the savings account's value at a fixed future date at a cheaper cost than the current value of the savings account. The benchmark approach is formulated under the real world probability measure and does not require the existence of a risk neutral probability measure. It hence emerges as the appropriate framework to study the potential existence of money market bubbles. Testing the existence of money market bubbles in the US economy we nd that for all models the US market exhibits a money market bubble. This conclusion suggests that for derivative pricing and hedging care should be taken when making assumptions pertaining to the existence of a risk-neutral probability measure. Less expensive hedge portfolios may exist for a wide range of derivatives.

Keywords: money market bubbles; strict local martingales; Markov chain Monte Carlo; stochastic volatility models; benchmark approach

JEL Classification: C6, C63, G1, G13

Suggested Citation

Baldeaux, Jan F. and Ignatieva, Katja and Ignatieva, Katja and Platen, Eckhard, Detecting Money Market Bubbles (October 17, 2016). Available at SSRN: https://ssrn.com/abstract=2853051 or http://dx.doi.org/10.2139/ssrn.2853051

Jan F. Baldeaux

Standard Chartered Bank ( email )

United States

Katja Ignatieva (Contact Author)

University of New South Wales (UNSW) ( email )

Kensington
High St
Sydney, NSW 2052
Australia

HOME PAGE: http://www.asb.unsw.edu.au/schools/Pages/KatjaIgnatieva.aspx

University of New South Wales - Australian School of Business ( email )

UNSW Business School
High St
Sydney, NSW 2052
Australia

Eckhard Platen

University of Technology, Sydney (UTS) - Finance Discipline Group ( email )

Broadway
GPO Box 123
Sydney, NSW 2007, 2007
Australia
+61 2 9514 7759 (Phone)

HOME PAGE: http://datasearch.uts.edu.au/business/finance/staff/StaffDetails.cfm?UnitStaffId=90

University of Technology Sydney, School of Mathematical and Physical Sciences ( email )

P.O. Box 123
Broadway
Sydney, New South Wales 2007
Australia
+61 (02) 9514 2271 (Phone)

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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