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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 recursive preferences and a L´evy 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, with closed-form analytical solutions for the asset prices. We show that the non-Gaussianity of fundamentals due to time-deformation induces risk compensations whidh depend on higher order moments of consumption and dividend series. Persistence of the activity shocks leads to predictability of the endowment streams and timevariation in asset prices and risk premia. In numerical calibrations, we show that the compensation for L´evy risks accounts for about one-third of the overall risk premium in the economy.

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Bibliographic Info

Paper provided by Duke University, Department of Economics in its series Working Papers with number 10-71.

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Length: 31
Date of creation: 2009
Date of revision:
Handle: RePEc:duk:dukeec:10-71

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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; L´evy processes; recursive preferences;

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