Pricing Long-Lived Securities in Dynamic Endowment Economies
39 Pages Posted: 21 Apr 2017 Last revised: 8 Aug 2017
Date Written: August 3, 2017
We solve for asset prices in a general affine representative-agent economy with isoelastic recursive utility and rare events. Our novel solution method is exact in two special cases: no preference for early resolution of uncertainty and elasticity of intertemporal substitution equal to one. Our results clarify model properties governed by the elasticity of intertemporal substitution, by risk aversion, and by the preference for early resolution of uncertainty. Our results also highlight that a covariance-based factor structure arises as a very special case, rather than as a general property, of equilibrium models.
Keywords: rare events, recursive utility, factor models
JEL Classification: G12
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