Pricing of the time-change risks

Ivan Shaliastovich and George Tauchen

Journal of Economic Dynamics and Control, 2011, vol. 35, issue 6, pages 843-858

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.

Keywords: Time; deformation; Risk; premium; Recursive; utility (search for similar items in EconPapers)
Date: 2011
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Persistent link: http://EconPapers.repec.org/RePEc:eee:dyncon:v:35:y:2011:i:6:p:843-858

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