Equilibrium Asset Pricing in Directed Networks
68 Pages Posted: 11 Nov 2014 Last revised: 30 Oct 2017
Date Written: October 14, 2017
The direction of links in cash flow networks affects the cross-section of return volatilities, market prices of risk, and Sharpe ratios. We propose a flexible and tractable general equilibrium asset pricing model featuring a directed network. The model is based on mutually exciting jump processes in cash flows, and we suggest the shock propagation capacity (spc) of an asset implied by these dynamics as a measure for directedness. In our model, the higher spc, the lower the return volatility, and the higher the market price of jump risk. As an illustration we estimate an empirical network from industry cash flow data and find support for these predictions.
Keywords: General equilibrium asset pricing, recursive preferences, dynamic networks, mutually exciting processes, directed shocks
JEL Classification: G01, G12, D85
Suggested Citation: Suggested Citation