Arbitrage Free Dispersion

Piotr Orłowski, Andras Sali and Fabio Trojani
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Piotr Orłowski: HEC Montreal
Andras Sali: Alphacruncher
Fabio Trojani: Swiss Finance Institute; University of Geneva

No 19-20, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: We develop a theory of arbitrage-free dispersion (AFD) that characterizes the testable restrictions of asset pricing models. AFD measures Jensen’s gap in the cumulant generating function of pricing kernels and returns. It implies a wide family of model-free dispersion constraints, which extend dispersion and co-dispersion bounds in the literature and are applicable with a unifying approach in multivariate and multiperiod settings. Empirically, the dispersion of stationary and martingale pricing kernel components in the benchmark long-run risk model yields a counterfactual dependence of short- vs. long-maturity bond returns and is insufficient for pricing optimal portfolios of market equity and short-term bonds.

Keywords: Arbitrage-Free Dispersion; Cumulant Generating Function; Convexity; Convex Inequalities; Jensen’s Gap; Pricing Kernel Bounds; Entropy; Long-Run Risk Models; Tests of Asset Pricing Models (search for similar items in EconPapers)
JEL-codes: C14 C52 C58 G12 G15 (search for similar items in EconPapers)
Pages: 78 pages
Date: 2019-01, Revised 2019-04
New Economics Papers: this item is included in nep-ore and nep-rmg
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1920

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