On the Relation between Linearity-Generating Processes and Linear-Rational Models

Damir Filipović, Martin Larsson and Anders B. Trolle
Additional contact information
Damir Filipović: Ecole Polytechnique Fédérale de Lausanne; Ecole Polytechnique Fédérale de Lausanne - Swiss Finance Institute
Martin Larsson: ETH Zurich - Department of Mathematics
Anders B. Trolle: Ecole Polytechnique Fédérale de Lausanne; Ecole Polytechnique Fédérale de Lausanne - Swiss Finance Institute

No 16-23, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: We review the notion of a linearity-generating (LG) process introduced by Gabaix (2009) and relate LG processes to linear-rational (LR) models studied in Filipovic, Larsson, and Trolle (2014). We show that every LG process can be represented as an LR model of the same dimension. More importantly, we identify those (m 1)-dimensional LG processes that can be represented as m-dimensional LR models. We show that these are the only LG processes that are stationary and mean-reverting after exponential scaling. We highlight the ease with which LR models can be specified and be made consistent with nonnegative interest rates. We also show that LR models fit naturally into the state price density factorization due to Alvarez and Jermann (2005) and Hansen and Scheinkman (2009).

Keywords: Linearity-Generating Process; Linear-Rational Model; Long-Term Risk; State Price Density (search for similar items in EconPapers)
JEL-codes: C32 G12 G13 (search for similar items in EconPapers)
Pages: 22 pages
Date: 2016-03
References: Add references at CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://ssrn.com/abstract=2753484 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1623

Access Statistics for this paper

More papers in Swiss Finance Institute Research Paper Series from Swiss Finance Institute Contact information at EDIRC.
Bibliographic data for series maintained by Ridima Mittal ().