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Extension of the Capital Asset Pricing Model to Non-normal Dependence Structures

Published online by Cambridge University Press:  17 April 2015

Mark Johnston
Mark Johnston*
Affiliation:
PricewaterhouseCoopers, GPO Box 2650, Sydney NSW 1171, Australia and University of New South Wales, Sydney NSW 2052, Australia, E-mail: [email protected]
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Abstract

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The Capital Asset Pricing Model arises in an economy where agents have exponential utility functions and aggregate consumption is normally distributed, and gives the prices of assets with payoffs which are jointly normal with consumption. Such assets have normal marginal distributions and have dependence with consumption characterised by a normal copula. Wang has derived a transform which extends the CAPM by allowing pricing of assets in such an economy which have non-normal marginal distributions but still are normal-copula with consumption.

Here we set out the stochastic discount factors corresponding to this version of the CAPM and to Wang’s transform, and show how to calculate stochastic discount factors and hence asset prices for assets whose dependence with consumption is non-normal. We show that the impact of dependency structure on asset prices is significant.

Keywords

CAPMstochastic discount factorcredit riskcredit spreadcopulaWang transform
Type
Articles
Information
ASTIN Bulletin: The Journal of the IAA , Volume 37 , Issue 1 , May 2007 , pp. 35 - 52
Copyright
Copyright © ASTIN Bulletin 2007

Footnotes

5

Present address: Macquarie Bank, 1 Martin Place, Sydney NSW 2000, Australia.

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