Interest rate risk premium and equity valuation |
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Authors: | Zhuang Kang Srdjan D Stojanovic |
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Institution: | (1) Technology Management and Financial Engineering, Polytechnic University, Six MetroTech Center, 11201 Brooklyn, NY, USA |
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Abstract: | The authors employ the recent stochastic-control-based approach to financial mathematics to solve a problem of determination
of the risk premium for a stochastic interest rate model, and the corresponding problem of equity valuation. The risk premium
is determined explicitly, by means of solving a corresponding partial differential equation (PDE), in two forms: one, time-dependent,
corresponding to a finite time contract expiration, and the simpler version corresponding to perpetual contracts. As stocks
are perpetual contracts, when solving the problem of equity valuation, the latter form of the risk premium is used. By means
of solving the general pricing PDE, an efficient equity valuation method was developed that is a combination of some sophisticated
explicit formulas, and a numerical procedure. |
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Keywords: | |
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