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Pricing Corporate Securities under Noisy Asset Information

by Rüdiger Frey of the University of Leipzig, and
Thorsten Schmidt of the University of Leipzig

May 7, 2007

Abstract: This paper considers the pricing of corporate securities of a given firm, in particular equity, when investors do not have full information on the firm's asset value. We show that under noisy asset information, the pricing of corporate securities leads to a nonlinear filtering problem. This problem is solved by a Markov chain approximation, leading to an efficient finite-dimensional approximative filter for the asset value. We discuss several applications and illustrate our results with a simulation study.

Keywords: Firm value models, incomplete information, nonlinear filtering.

Published in: Mathematical Finance, Vol. 19, No. 3, (July 2009), pp. 403-421.

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