Pricing of the Time-Change Risks

32 Pages Posted: 9 Oct 2010

See all articles by George Tauchen

George Tauchen

Duke University - Economics Group

Ivan Shaliastovich

University of Wisconsin - Madison

Multiple version iconThere are 2 versions of this paper

Date Written: November 2009

Abstract

We develop a discrete-time real endowment economy featuring recursive preferences 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, with closed-form analytical solutions for the asset prices. We show that the non-Gaussianity of fundamentals due to time-deformation induces risk compensations which depend on higher order moments of consumption and dividend series. Persistence of the activity shocks leads to predictability of the endowment streams and time variation in asset prices and risk premia. In numerical calibrations, we show that the compensation for Levy risks accounts for about one-third of the overall risk premium in the economy.

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

JEL Classification: G12, D51, C51

Suggested Citation

Tauchen, George E. and Shaliastovich, Ivan, Pricing of the Time-Change Risks (November 2009). Economic Research Initiatives at Duke (ERID) Working Paper No. 71, Available at SSRN: https://ssrn.com/abstract=1687963 or http://dx.doi.org/10.2139/ssrn.1687963

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)

Ivan Shaliastovich

University of Wisconsin - Madison ( email )

716 Langdon Street
Madison, WI 53706-1481
United States

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