HETEROGENEITY IN RISK PREFERENCES LEADS TO STOCHASTIC VOLATILITY

Dietmar P. J. Leisen ()
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Dietmar P. J. Leisen: Faculty of Law and Economics, University of Mainz, Mainz 55099, Germany

International Journal of Theoretical and Applied Finance (IJTAF), 2018, vol. 21, issue 06, 1-27

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.

Keywords: Stochastic volatility; state-dependent volatility; heterogeneity (search for similar items in EconPapers)
Date: 2018
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DOI: 10.1142/S0219024918500358

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