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The Equilibrium Valuation of Risky Discrete Cash Flows in Continuous Time

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  • Shimko, David C

Abstract

This paper values a contingent claim to discrete stochastic cash flows generated by a Poisson arrival process with a randomly varying intensity parameter. In the most general case, both the size and the arrival intensity of cash flows may correlate with state variables in a continuous time economy. Assuming the conditions of an intertemporal capital asset pricing model, solutions for the value of the contingent claim can be found using various techniques. The paper suggests immediate applications to the valuation of insurance contracts, the decision to build a firm with unknown future investment opportunities, and the pricing of mortgaged-backed securities. Copyright 1989 by American Finance Association.

Suggested Citation

  • Shimko, David C, 1989. " The Equilibrium Valuation of Risky Discrete Cash Flows in Continuous Time," Journal of Finance, American Finance Association, vol. 44(5), pages 1357-1383, December.
  • Handle: RePEc:bla:jfinan:v:44:y:1989:i:5:p:1357-83
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    References listed on IDEAS

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    1. N. Gregory Mankiw & Lawrence H. Summers, 1984. "Do Long-Term Interest Rates Overreact to Short-Term Interest Rates?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 15(1), pages 223-248.
    2. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1981. "A Re-examination of Traditional Hypotheses about the Term Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 36(4), pages 769-799, September.
    3. McCulloch, J Huston, 1971. "Measuring the Term Structure of Interest Rates," The Journal of Business, University of Chicago Press, vol. 44(1), pages 19-31, January.
    4. Campbell, John Y & Shiller, Robert J, 1984. "A Simple Account of the Behavior of Long-Term Interest Rates," American Economic Review, American Economic Association, vol. 74(2), pages 44-48, May.
    5. Robert J. Shiller & John Y. Campbell & Kermit L. Schoenholtz, 1983. "Forward Rates and Future Policy: Interpreting the Term Structure of Interest Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, pages 173-224.
    6. Fama, Eugene F., 1984. "The information in the term structure," Journal of Financial Economics, Elsevier, vol. 13(4), pages 509-528, December.
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    Cited by:

    1. Martin, J. Spencer & Santomero, Anthony M., 1997. "Investment opportunities and corporate demand for lines of credit," Journal of Banking & Finance, Elsevier, vol. 21(10), pages 1331-1350, October.
    2. Grenadier, Steven R. & Hall, Brian J., 1996. "Risk-based capital standards and the riskiness of bank portfolios: Credit and factor risks," Regional Science and Urban Economics, Elsevier, vol. 26(3-4), pages 433-464, June.
    3. Lin, Chung-Gee & Yang, Wei-Ning & Chen, Shu-Chuan, 2014. "Analyses of retirement benefits with options," Economic Modelling, Elsevier, vol. 36(C), pages 130-135.
    4. Riddiough, Timothy J., 1997. "The Economic Consequences of Regulatory Taking Risk on Land Value and Development Activity," Journal of Urban Economics, Elsevier, vol. 41(1), pages 56-77, January.
    5. Steven R. Grenadier & Brian J. Hall, 1995. "Risk-Based Capital Standards and the Riskiness of Bank Portfolios: Credit and Factor Risks," NBER Working Papers 5178, National Bureau of Economic Research, Inc.
    6. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.

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