William Brock

Paper #: 93-02-006

The paper: (1) Gives a general argument why research on nonlinear science in general and chaos in particular is important in economics and finance. (2) Puts forth two definitions of stochastic nonlinearity (IID-Linearity and MDS-Linearity) for nonlinear time series analysis and argues for their usefulness as organizing concepts not only for discussion of nonlinearity testing in time series econometrics but also for building a new class of structural asset pricing models. (3) Shows how to use ideas from interacting particle systems theory to build structural asset pricing models that turn IID-Linear or MDS-Linear earnings processes into non MDS-Linear equilibrium returns processes.