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Pricing of the time-change risks

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  • Shaliastovich, Ivan
  • Tauchen, George

Abstract

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.

Suggested Citation

  • Shaliastovich, Ivan & Tauchen, George, 2011. "Pricing of the time-change risks," Journal of Economic Dynamics and Control, Elsevier, vol. 35(6), pages 843-858, June.
  • Handle: RePEc:eee:dyncon:v:35:y:2011:i:6:p:843-858
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    More about this item

    Keywords

    Time deformation Risk premium Recursive utility;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • D51 - Microeconomics - - General Equilibrium and Disequilibrium - - - Exchange and Production Economies
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation

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