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Pricing of the Time-Change Risks

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  • Ivan Shaliastovich
  • George Tauchen

Abstract

We develop a discrete-time real endowment economy featuring Epstein-Zin recursive utility and a Levy time-change subordinator, which represents a clock that connects business time to calendar time. This setup provides a convenient equilibrium framework for pricing non-Gaussian risks, where the solutions for financial prices are available up to integral operations in general, or in closed-form for tempered stable shocks. The non-Gaussianity of fundamentals due to time-deformation induces compensations for higher order moments and co-moments of consumption and dividend growth rates of the assets. Forecastability of the time change leads to predictability of the endowment streams and therefore to time-variation in financial prices and risk premia on assets. In numerical calibrations, we quantitatively analyze the compensations for different types of systematic risk.

Suggested Citation

  • Ivan Shaliastovich & George Tauchen, 2010. "Pricing of the Time-Change Risks," Working Papers 10-10, Duke University, Department of Economics.
  • Handle: RePEc:duk:dukeec:10-10
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    References listed on IDEAS

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    More about this item

    Keywords

    Risk premium; time change; Levy processes; recursive preferences;

    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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