A class of asset pricing models governed by subordinate processes that signal economic shocks

Abstract

We consider a mean-reverting risk-neutral short rate process model with a vector of subordinated drift processes that accounts for the random effect of the arrival of new information. It is assumed that the market is efficient with no arbitrage opportunities. Closed form expressions for the price in nominal and in real terms of a discount bond are obtained. We define a risk-neutral exchange rate model with correlated subordinated drift and volatility processes that reflect the effect of the arrival of new information pertaining to the countries involved. The cases of complete and incomplete exchange markets with no arbitrage opportunities are considered.Mean reverting Ito process Stochastic volatility Economic shock process Risk premia Stochastic interest rate Risk-neutral process Subordinated processes Brownian motion models Foreign exchange markets Incomplete/complete markets