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Risk Pricing over Alternative Investment Horizons

  • Lars Peter Hansen

    ()

    (The University of Chicago)

I explore methods that characterize model-based valuation of stochastically growing cash flows. Following previous research, I use stochastic discount factors as a convenient device to depict asset values. I extend that literature by focusing on the impact of compounding these discount factors over alternative investment horizons. In modeling cash flows, I also incorporate stochastic growth factors. I explore dynamic value decomposition (DVD) methods that capture concurrent compounding of a stochastic growth and discount factors in determining risk-adjusted values. These methods are supported by factorizations that extract martingale components of stochastic growth and discount factors. These components reveal which ingredients of a model have long-term implications for valuation. The resulting martingales imply convenient changes in measure that are distinct from those used in mathematical finance, and they provide the foundations for analyzing model-based implications for the term structure of risk prices. As an illustration of the methods, I re-examine some recent preference based models. I also use the martingale extraction to revisit the value implications of some benchmark models with market restrictions and heterogenous consumers.

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File URL: http://econresearch.uchicago.edu/sites/econresearch.uchicago.edu/files/BFI_2012-008.pdf
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Paper provided by Becker Friedman Institute for Research In Economics in its series Working Papers with number 2012-008.

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Date of creation: 2012
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Handle: RePEc:bfi:wpaper:2012-008
Contact details of provider: Web page: http://bfi.uchicago.edu/
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  20. Jaroslav Borovička & Lars Peter Hansen & Mark Hendricks & José A. Scheinkman, 2009. "Risk Price Dynamics," NBER Working Papers 15506, National Bureau of Economic Research, Inc.
    • Lars Peter Hansen & Jaroslav BoroviÄka & Mark Hendricks & Jose A. Scheinkman, 2010. "Risk Price Dynamics," Working Papers 2010-004, Becker Friedman Institute for Research In Economics.
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