How do investors' expectations drive asset prices?

How do investors’ expectations drive asset
prices?

Erik Lüders* Bernhard Peist

March 2001

Abstract

Asset price processes are completely described by information processes
and investors’ preferences. In this paper we derive the relationship be-
tween the process of investors’ expectations of the terminal stock price
and asset prices in a general continuous time pricing kernel framework.
To derive the asset price process we make use of the modern technique
of forward-backward stochastic differential equations. With this ap-
proach it is possible to show the driving factors for stochastic volatility
of asset prices and to give theoretical arguments for empirically well
documented facts. We show that stylized facts that look at first hand
like financial market anomalies may be explained by an information
process with stochastic volatility.

JEL Classification: C69, G12

Keywords and Phrases: backward stochastic differential equations,
information processes, pricing kernel

*Center of Finance and Econometrics, University of Konstanz and Zentrum für Eu-
ropaische Wirtschaftsforschung (ZEW), Mannheim

Email : Erik. Lueders ©uni-konst anz. de

!Center of Finance and Econometrics, University of Konstanz

Email: [email protected]

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