Pricing of the Time-Change Risks

41 Pages Posted: 1 Aug 2008 Last revised: 13 Dec 2011

Ivan Shaliastovich

University of Wisconsin - Madison

George Tauchen

Duke University - Economics Group

Multiple version iconThere are 2 versions of this paper

Date Written: April 1, 2008

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.

Keywords: Risk premium, time change, Levy processes, recursive preferences

JEL Classification: G12, D51, C51

Suggested Citation

Shaliastovich, Ivan and Tauchen, George, Pricing of the Time-Change Risks (April 1, 2008). Economic Research Initiatives at Duke (ERID) Working Paper No. 4. Available at SSRN: https://ssrn.com/abstract=1188783 or http://dx.doi.org/10.2139/ssrn.1188783

Ivan Shaliastovich

University of Wisconsin - Madison ( email )

716 Langdon Street
Madison, WI 53706-1481
United States

George E. Tauchen (Contact Author)

Duke University - Economics Group ( email )

Box 90097
221 Social Sciences
Durham, NC 27708-0097
United States
919-660-1812 (Phone)
919-684-8974 (Fax)

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