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Heterogeneity In Risk Preferences Leads To Stochastic Volatility

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  • DIETMAR P. J. LEISEN

    (Faculty of Law and Economics, University of Mainz, Mainz 55099, Germany)

Abstract

This paper studies the price processes of a claim on terminal endowment and of a claim on firm book value when the underlying variables follow a bivariate geometric Brownian motion. If the state-price process is multiplicatively separable into time and endowment functions, our main result shows that firm (endowment) price volatility is stochastic (state-dependent) if, and only if, the endowment function is not a power function. In a pure exchange economy populated by two agents with constant relative risk aversion (CRRA) preferences we confirm the separability, and we show furthermore that firm (endowment) price volatility is stochastic (state-dependent) if, and only if, both agents are heterogeneous in risk-preferences.

Suggested Citation

  • Dietmar P. J. Leisen, 2018. "Heterogeneity In Risk Preferences Leads To Stochastic Volatility," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 21(06), pages 1-27, September.
    • Handle: RePEc:wsi:ijtafx:v:21:y:2018:i:06:n:s0219024918500358
    DOI: 10.1142/S0219024918500358
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    References listed on IDEAS

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