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Pricing of the time-change risks

  • Shaliastovich, Ivan
  • Tauchen, George

We develop an equilibrium endowment economy with Epstein-Zin recursive utility and a Lévy time-change subordinator, which represents a clock that connects business and calendar time. Our setup provides a tractable equilibrium framework for pricing non-Gaussian jump-like risks induced by the time-change, with closed-form solutions for asset prices. Persistence of the time-change shocks leads to predictability of consumption and dividends and time-variation in asset prices and risk premia in calendar time. In numerical calibrations, we show that the risk compensation for Lévy risks accounts for about one-third of the overall equity premium.

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File URL: http://www.sciencedirect.com/science/article/B6V85-51XH963-3/2/b8b83a2b4db4cd425fdc57a847af8935
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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 35 (2011)
Issue (Month): 6 (June)
Pages: 843-858

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Handle: RePEc:eee:dyncon:v:35:y:2011:i:6:p:843-858
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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