ePrints@IIScePrints@IISc Home | About | Browse | Latest Additions | Advanced Search | Contact | Help

Rational functions: an alternative approach to asset pricing

Chakraborty, N and Elgammal, MM and McMillan, D (2019) Rational functions: an alternative approach to asset pricing. In: Applied Economics, 51 (20). pp. 2091-2119.

app_eco_51-20_2091-2119_2019.pdf - Published Version

Download (2MB) | Preview
Official URL: https://doi.org/10.1080/00036846.2018.1540848


This paper shows that asset prices are linear polynomials of various underlying explanatory factors and asset returns being ratios of these polynomials, are rational functions that do not add linearly when averaging. Hence, average returns should be modeled based on stock prices. However, continuous returns may be treated as approximately linear across time and modeled directly. Our new Rational Function (RF) models, empirically outperform the traditional asset pricing models like the Capital Asset Pricing Model (CAPM) and the Fama–French three and five-factor models for both average and continuous returns. Moreover, the RF theory also provides a model to estimate the asset volumes. The average change in asset volumes together with average returns provide the estimates for average change in market values of assets. Thus, the RF model approach can be used to select assets that provide either highest returns for profit maximization or highest change in market values for wealth maximization for given levels of risk.

Item Type: Journal Article
Publication: Applied Economics
Publisher: Routledge
Additional Information: The copyright for this article belongs to the Authors.
Keywords: capital market; econometrics; empirical analysis; linearity; price dynamics; pricing policy; stock market
Department/Centre: Others
Date Deposited: 25 Oct 2022 09:46
Last Modified: 25 Oct 2022 09:46
URI: https://eprints.iisc.ac.in/id/eprint/77536

Actions (login required)

View Item View Item