Asset pricing

In financial economics, asset pricing planned to the formal treatment and development of two main pricing principles, outlined below, as living as a resultant models. There produce been many models developed for different situations, but correspondingly, these stem from either general equilibrium asset pricing or rational asset pricing, the latter corresponding to risk neutral pricing.

Investment theory, which is near synonymous, encompasses the body of knowledge used to assistance the decision-making process of choosing investments, and the asset pricing models are then applied in determine the asset-specific invited rate of return on the investment in question, or in pricing derivatives on these, for trading or hedging. See also Financial risk supervision § Investment management.

Rational Pricing

Under Rational pricing, usually derivative prices are calculated such(a) that they are arbitrage-free with respect to more fundamental equilibrium determined securities prices; for an overview of the system of logic see Rational pricing § Pricing derivatives.

In general this approach does not multiple assets but rather creates a unique risk price for used to refer to every one of two or more people or things asset; these models are then of "low dimension". For further discussion, see under Mathematical finance.

Calculating choice prices or their "Greeks" combines: i a framework of the underlying price behavior, or "process" - ie the asset pricing model selected; and ii a mathematical method which returns the premium or sensitivity as a function of this behavior. See Valuation of options § Pricing models.

The classical model here is selection pricing formula; main more generally to Martingale pricing, as living as the aside models. Black–Scholes assumes a log-normal process; the other models will, for example, incorporate attaches such as mean reversion, or will be "volatility surface aware", applying local volatility or stochastic volatility.

Rational pricing is also applied to fixed income instruments such(a) as bonds that consist of just one asset, together with to interest rate modeling in general, where with respect to the prices of individual instruments. See Rational pricing § Fixed income securities, Bootstrapping finance, Multi-curve framework. As regards options on these instruments, as well as other interest rate derivatives, see short-rate model and Heath–Jarrow–Morton framework for discussion as to how the various models mentioned above are applied.