We study the pricing and hedging of contingent claims that are subject to Event Risk which we define as rare and unpredictable events whose occurrence may be correlated to, but cannot be hedged perfectly with standard marketed instruments. The super and sub-replication costs of such event...

We study portfolio choice when labor income and dividends are cointegrated. Economically plausible calibrations suggest young investors should take substantial short positions in the stock market. Because of cointegration the young agent's human capital electively becomes stock-like. However,...

Prior to the stock market crash of 1987, Black-Scholes implied volatilities of Samp;P 500 index options were relatively constant across moneyness. Since the crash, however, deep out-of-the-money Samp;P 500 put options have become 'expensive' relative to the Black-Scholes benchmark. Many...

Empirical evidence shows that changes in aggregate labor income and stock market returns exhibit only weak correlation at short horizons. As we document below, however, this correlation increases substantially at longer horizons, which provides at least suggestive evidence that stock returns and...

Most term structure models with stochastic volatility are restrictive in that they assume the risk in derivative securities can be perfectly hedged by a portfolio consisting solely of bonds. Below, we demonstrate that this prediction fails in practice. In particular, we find that the changes in...

Empirical evidence shows that changes in aggregate labor income and stock market returns exhibit only weak correlation at short horizons. As we document below, however, this correlation increases substantially at longer horizons, which provides at least suggestive evidence that stock returns and...

Structural models of default calibrated to historical default rates, recovery rates, and Sharpe ratios typically generate Baa-Aaa credit spreads that are significantly below historical values. However, this credit spread puzzle can be resolved if one accounts for the fact that default rates and...

Most models of the term structure are restrictive in that they assume the bond market forms a complete market. That is, they assume all sources of risk affecting fixed income derivatives can be completely hedged by a portfolio consisting solely of bonds. Below, we present empirical evidence...

We propose a very fast and accurate algorithm for pricing swaptions when the underlying term structure dynamics are affine. The efficiency of the algorithm stems from the fact that the moments of the underlying asset (i.e., a coupon bond) possess simple closed-form solutions. These moments...

Using straight industrial bonds with quoted prices, we investigate the determinants of credit spread changes. We find the variables that should in theory determine credit spread changes in fact have limited explanatory power. Further, the residuals from this first-pass regression are highly...