A LIST OF POSSIBLE TOPICS FOR A THESIS IN ASSET PRICING

Stefano Herzel

What follows is a list of classical and important papers in finance which I like. Each one of them may be a possible starting point for a thesis in Asset Pricing.
In general your thesis should try to replicate the results of the paper on a different data set (if it is an empirical paper) or to implement its results on Matlab and do some simulations or similar analysis (if it is a theoretical paper). You may also start from one paper and follow the more recent literature to see where we stand now.
If you are interested in one topic, read the introduction to the paper. If you like it, contact me to see if it is still available for a thesis. If not, choose a different topic (or a different supervisor!).

1.
Implementing Option Pricing Models When Asset Returns Are Predictable
ANDREW W. LO JIANG WANG
First published: March 1995 https://doi.org/10.1111/j.1540-6261.1995.tb05168.x Cited by: 44
 

 

ABSTRACT
The predictability of an asset's returns will affect the prices of options on that asset, even though predictability is typically induced by the drift, which does not enter the option pricing formula. For discretely‐sampled data, predictability is linked to the parameters that do enter the option pricing formula. We construct an adjustment for predictability to the Black‐Scholes formula and show that this adjustment can be important even for small levels of predictability, especially for longer maturity options. We propose several continuous‐time linear diffusion processes that can capture broader forms of predictability, and provide numerical examples that illustrate their importance for pricing options.

2.
THE JOURNAL OF FINANCE • VOL. LX, NO. 1 • FEBRUARY 2005
Does the Failure of the Expectations Hypothesis Matter for Long-Term Investors?
ANTONIOS SANGVINATSOS and JESSICA A. WACHTER∗ ABSTRACT
We solve the portfolio problem of a long-run investor when the term structure is Gaussian and when the investor has access to nominal bonds and stock. We apply our method to a three-factor model that captures the failure of the expectations hypothesis. We extend this model to account for time-varying expected inflation, and estimate the model with both inflation and term structure data. The estimates imply that the bond portfolio of a long-run investor looks very different from the portfolio of a mean- variance optimizer. In particular, time-varying term premia generate large hedging demands for long-term bonds.

3.
JOURNAL OF FINANCE * VOL. LXII, NO. 1 * FEBRUARY 2007

The Impact of Collateralization on Swap Rates MICHAEL JOHANNES and SURESH SUNDARESAN*
ABSTRACT
Interest rate swap pricing theory traditionally views swaps as a portfolio of fo contracts with net swap payments discounted at LIBOR rates. In practice, t of marking-to-market and collateralization questions this view as they intro termediate cash flows and alter credit characteristics. We provide a swap v theory under marking-to-market and costly collateral and examine the theory's ical implications. We find evidence consistent with costly collateral using two d approaches; the first uses single-factor models and Eurodollar futures prices, a second uses a formal term structure model and

4.
Locked Up by a Lockup: Valuing Liquidity as a Real Option
Andrew Ang and Nicolas P.B. Bollen∗
Hedge funds often impose lockups and notice periods to limit the ability of investors to withdraw capital. We model the investor’s decision to withdraw capital as a real option and treat lockups and notice periods as exercise restrictions. Our methodology incorporates time-varying probabilities of hedge fund failure and optimal early exercise. We estimate a two-year lockup with a three- month notice period costs approximately 1% of the initial investment for an investor with constant relative risk aversion utility and risk aversion of three. The cost of illiquidity can easily exceed 10% if the hedge fund manager can arbitrarily suspend withdrawals.

5.
JOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS VOL. 37, NO. 1, MARCH 2002 COPYRIGHT 2002, SCHOOL OF BUSINESS ADMINISTRATION, UNIVERSITY OF WASHINGTON, SEATTLE, WA 98195
Portfolio and Consumption Decisions under Mean-Reverting Returns: An Exact Solution for Complete Markets
Jessica A. Wachter
Abstract
This paper solves, in closed form, the optimal portfolio choice problem for an investor with utility over consumption under mean-reverting returns. Previous solutions either require approximations, numerical methods, or the assumption that the investor does not consume over his lifetime. This paper breaks the impasse by assuming that markets are complete. The solution leads to a new understanding of hedging demand and of the behavior of the approximate log-linear solution. The portfolio allocation takes the form of a weighted aver- age and is shown to be analogous to duration for coupon bonds. Through this analogy, the notion of investment horizon is extended to that of an investor who consumes at multiple points in time.

6. The Effect of Green Investment on Corporate Behavior Author(s): Robert Heinkel, Alan Kraus and Josef Zechner
The Journal of Financial and Quantitative Analysis, Vol. 36, No. 4 (Dec., 2001), pp. 431-449
This paper explores the effect of exclusionary ethical investing on corporate behavior in a risk-averse, equilibrium setting. While arguments exist that ethical investing can influence a firm's cost of capital, and so affect investment, no equilibrium model has been presented to do so. We show that exclusionary ethical investing leads to polluting firms being held by fewer investors since green investors eschew polluting firms' stock. This lack of risk sharing among non-green investors leads to lower stock prices for polluting firms, thus raising their cost of capital. If the higher cost of capital more than overcomes a cost of reforming (i.e., a polluting firm cleaning up its activities), then polluting firms will become socially responsible because of exclusionary ethical investing. A key determinant of the incentive for polluting firms to reform is the fraction of funds controlled by green investors. In our model, empirically reasonable parameter estimates indicate that more than 20% green investors are required to induce any polluting firms to reform. Existing empirical evidence indicates that at most 10% of funds are invested by green investors.

7. Learning about Predictability: The Effects of Parameter Uncertainty on Dynamic Asset Allocation
Yihong Xia
: The Journal of Finance, Vol. 56, No. 1 (Feb., 2001), pp. 205-246
This paper examines the effects of uncertainty about the stock return predictabil- ity on optimal dynamic portfolio choice in a continuous time setting for a long- horizon investor. Uncertainty about the predictive relation affects the optimal portfolio choice through dynamic learning, and leads to a state-dependent relation between the optimal portfolio choice and the investment horizon. There is substan- tial market timing in the optimal hedge demands, which is caused by stochastic covariance between stock return and dynamic learning. The opportunity cost of ignoring predictability or learning is found to be quite substantial.

8. Discount Rates
JOHN H. COCHRANE
THE JOURNAL OF FINANCE • VOL. LXVI, NO. 4 • AUGUST 2011

Discount-rate variation is the central organizing question of current asset-pricing re- search. I survey facts, theories, and applications. Previously, we thought returns were unpredictable, with variation in price-dividend ratios due to variation in expected cashflows. Now it seems all price-dividend variation corresponds to discount-rate variation. We also thought that the cross-section of expected returns came from the CAPM. Now we have a zoo of new factors. I categorize discount-rate theories based on central ingredients and data sources. Incorporating discount-rate variation affects finance applications, including portfolio theory, accounting, cost of capital, capital structure, compensation, and macroeconomics.

9. Option Pricing without Perfect Replication
Chapter 18 of  the book “Asset Pricing” by J. Cochrane.

The beautiful Black–Scholes formula launched a thousand techniques for option pricing. The principle of no-arbitrage pricing is obvious, but its application leads to many subtle and unanticipated pricing relationships.
However, in many practical situations, the law-of-one-price arguments that we used in the Black--Scholes formula break down. If options really were redundant, it is unlikely that they would be traded as separate assets. It really is easy to synthesize forward rates from zero-coupon bonds, and forward rates are not separately traded or quoted.

10. The relation between forward prices and futures prices
John C.CoxJonathan E.IngersollJr.Stephen A.Ross
Journal of Financial Economics
Volume 9, Issue 4, December 1981, Pages 321-346

Abstract
This paper consolidates the results of some recent work on the relation between forward prices and futures prices. It develops a number of propositions characterizing the two prices. These propositions contain several testable implications about the difference between forward and futures prices. Many of the propositions show that equilibrium forward and futures prices are equal to the values of particular assets, even though they are not in themselves asset prices. The paper then illustrates these results in the context of two valuation models and discusses the effects of taxes and other institutional factors.
https://www.sciencedirect.com/science/article/pii/0304405X81900027