Pricing Long-Lived Securities in Dynamic Endowment Economies
48 Pages Posted: 21 Apr 2017 Last revised: 11 Aug 2020
Date Written: May 16, 2018
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. Finally, we show in a general setting that the linear relationbetween normal-times covariances and expected returns need not hold in a model with rare events.
Keywords: rare events, recursive utility, factor models
JEL Classification: G12
Suggested Citation: Suggested Citation