Asset pricing with random information flow

TL;DR

This paper introduces a stochastic volatility asset pricing model with a randomly varying information flow rate, capturing market dynamics more realistically and demonstrating its ability to fit volatility surfaces and analyze price manipulation effects.

Contribution

It extends the information-based asset pricing framework by incorporating a random information flow rate, providing a more flexible and realistic model for market volatility and manipulation analysis.

Findings

The model captures key features of asset price dynamics.

Simulation studies illustrate characteristic behaviors of the price process.

The model can fit observed volatility surfaces effectively.

Abstract

In the information-based approach to asset pricing the market filtration is modelled explicitly as a superposition of signals concerning relevant market factors and independent noise. The rate at which the signal is revealed to the market then determines the overall magnitude of asset volatility. By letting this information flow rate random, we obtain an elementary stochastic volatility model within the information-based approach. Such an extension is economically justified on account of the fact that in real markets information flow rates are rarely measurable. Effects of having a random information flow rate is investigated in detail in the context of a simple model setup. Specifically, the price process of the asset is derived, and its characteristic behaviours are revealed via simulation studies. The price of a European-style option is worked out, showing that the model has a sufficient flexibility to fit volatility surface. As an extension of the random information flow model, price manipulation is considered. A simple model is used to show how the skewness of the manipulated and unmanipulated price processes take opposite signature.