  A new framework for asset pricing based on modelling the information
available to market participants is presented. Each asset is characterised by
the cash flows it generates. Each cash flow is expressed as a function of one
or more independent random variables called market factors or "X-factors". Each
X-factor is associated with a "market information process", the values of which
become available to market participants. In addition to true information about
the X-factor, the information process contains an independent "noise" term
modelled here by a Brownian bridge. The information process thus gives partial
information about the X-factor, and the value of the market factor is only
revealed at the termination of the process. The market filtration is assumed to
be generated by the information processes associated with the X-factors. The
price of an asset is given by the risk-neutral expectation of the sum of the
discounted cash flows, conditional on the information available from the
filtration. The theory is developed in some detail, with a variety of
applications to credit risk management, share prices, interest rates, and
inflation. A number of new exactly solvable models are obtained for the price
processes of various types of assets and derivative securities; and a novel
mechanism is proposed to account for the dynamics of stochastic volatility and
dynamic correlation. A discrete-time version of the information-based framework
is also developed, and is used to construct a new class of models for the real
and nominal interest rate term structures, and the dynamics of the associated
price index.
