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The intrinsic bounds on the risk premium of Markovian pricing kernels

Author

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  • Han, Jihun
  • Park, Hyungbin

Abstract

The risk premium is one of main concepts in mathematical finance. It is a measure of the trade-offs investors make between return and risk and is defined by the excess return relative to the risk-free interest rate that is earned from an asset per one unit of risk. The purpose of this article is to determine upper and lower bounds on the risk premium of an asset based on the market prices of options. One of the key assumptions to achieve this goal is that the market is Markovian. Under this assumption, we can transform the problem of finding the bounds into a second-order differential equation. We then obtain upper and lower bounds on the risk premium by analyzing the differential equation.

Suggested Citation

  • Han, Jihun & Park, Hyungbin, 2015. "The intrinsic bounds on the risk premium of Markovian pricing kernels," Finance Research Letters, Elsevier, vol. 13(C), pages 36-44.
    • Handle: RePEc:eee:finlet:v:13:y:2015:i:c:p:36-44
    DOI: 10.1016/j.frl.2015.03.005
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    References listed on IDEAS

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    1. Hyungbin Park, 2014. "Pricing and Hedging Long-Term Options," Papers 1410.8160, arXiv.org, revised Mar 2016.
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    Cited by:

    1. Hyungbin Park, 2015. "Sensitivity Analysis of Long-Term Cash Flows," Papers 1511.03744, arXiv.org, revised Sep 2018.

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    More about this item

    Keywords

    Risk premium; Markovian pricing kernel; Intrinsic bounds;
    All these keywords.

    JEL classification:

    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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