Inference on Risk-Neutral Measures for Incomplete Markets
Posted: 30 Jun 2009
Date Written: Summer 2009
Abstract
This paper proposes an econometric framework to estimate market risk prices associated with risk-neutral measures Q under incomplete markets. We show that, under incomplete markets, the market price of risk is not point-identified but is instead identified as a bounded subset of an affine subspace. On the other hand, a structural assumption fully identifies diffusion coefficients for the data-generating probability measure P. We apply Kaido and White's (, Discussion Paper, University of California, San Diego) two-stage extension of Chernozhukov, Hong, and Tamer's (, Econometrica, 75(5), 1243-1284) partial identification framework to construct a set estimator and confidence regions for the identified set of market risk prices and to test hypotheses. We apply our results to study international risk sharing and risk premiums for market cap range indexes.
Keywords: C12, C13, G12, incomplete markets, partial identification, risk-neutral measure, set estimation
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