Daucus carrota Professor André Farber Solvay Business School

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Presentation transcript:

Daucus carrota Professor André Farber Solvay Business School Université Libre de Bruxelles

Theory of asset pricing under certainty 1930 Fisher Theory of Interest Williams Theory of Investment Value 1940 1950 Hirshleifer Theory of Optimal Investment Decisions 1960 Daucus carota

Theory of asset pricing under uncertainty 1950 Markowitz Portfolio theory Arrow State prices 1960 Arrow Debreu General equilibrium Sharpe Lintner CAPM 1970 Black Scholes Merton OPM Ross APT Lucas Asset Prices Ross Risk neutral pricing Vasiceck Term structure Cox Ross Rubinstein Binomial OPM Harrison Kreps Martingales 1980 1990 Cochrane – Campbell: p = E(MX) 2000 Daucus carota

Three views of asset pricing General equilibrium Mean variance efficiency Beta pricing Stochastic discount factors Factor model + No arbitrage Risk-neutral pricing State prices linear pricing rule Complete markets No arbitrage (NA) Law of one price (LOOP) Adapted from Cochrane Figure 6.1 Daucus carota

Review: valuing uncertain cash flows CAPM Sharpe Lintner Mean Variance Pricing APT Ross State prices Law of one price No arbitrage opportunities Risk neutral pricing Daucus carota

Data Market Project Investment = 30m Company Price Future payoff (m€) Rain Proba = 0.40 Sun Proba = 0.60 Mkt Portf. 100 80.46 128.61 Gov. Bond 105 Market Type of weather Rain Sun Payoff 45m€ 35m€ Project Investment = 30m Daucus carota

Market portfolio - statistics Company Price Future payoff (m€) Rain Proba = 0.40 Sun Proba = 0.60 Mkt Portf. 100 80.46 128.61 Returns -19.54% 28.61% Expected return: rM = 9.35% Market risk premium rM – rf = 4.35% Variance Price of covariance risk Daucus carota

2. Project Expected cash flow Covariance with mkt port. Type of weather Rain (0.40) Sun (0.60) Payoff C 45m€ 35m€ Return Mkt Portfolio -19.54% 28.61% Expected cash flow Covariance with mkt port. Certainty equivalent: Daucus carota

Details of previous calculations Sun (0.60) Rain (0.40) Mkt Portfolio 28.61% -19.54% Project 35 45 Daucus carota

3. Net Present Value of the project. Sun 35 -7.90% Rain 45 18.41% PV (Payoff) NPV = 38 – 30 = +8 >0 Expected return = 2.62% Beta Daucus carota

4. State prices valuation Daucus carota

5. Risk neutral pricing Daucus carota

John Campbell Asset Pricing at the Millenium Journal of Finance 55,4 (Aug. 2000) Daucus carota

Stochastic Discount Factors Daucus carota