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Pricing of the Time-Change Risks

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  • Ivan Shaliastovich
  • George Tauchen

Abstract

We develop a discrete-time real endowment economy featuring Epstein-Zin recursive utility and a Levy time-change subordinator, which represents a clock that connects business time to calendar time. This setup provides a convenient equilibrium framework for pricing non-Gaussian risks, where the solutions for financial prices are available up to integral operations in general, or in closed-form for tempered stable shocks. The non-Gaussianity of fundamentals due to time-deformation induces compensations for higher order moments and co-moments of consumption and dividend growth rates of the assets. Forecastability of the time change leads to predictability of the endowment streams and therefore to time-variation in financial prices and risk premia on assets. In numerical calibrations, we quantitatively analyze the compensations for different types of systematic risk.

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Bibliographic Info

Paper provided by Duke University, Department of Economics in its series Working Papers with number 10-10.

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Length: 41
Date of creation: 2010
Date of revision:
Handle: RePEc:duk:dukeec:10-10

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Postal: Department of Economics Duke University 213 Social Sciences Building Box 90097 Durham, NC 27708-0097
Phone: (919) 660-1800
Fax: (919) 684-8974
Web page: http://econ.duke.edu/

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Keywords: Risk premium; time change; Levy processes; recursive preferences;

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