Heterogeneity in Risk Preferences Leads to Stochastic Volatility

30 Pages Posted: 29 Jun 2018

See all articles by Dietmar Leisen

Dietmar Leisen

Johannes Gutenberg University Mainz - Department of Banking

Date Written: June 21, 2018

Abstract

This paper studies the price processes of a claim on terminal endowment and of a claim on firm book value when the underlying variables follow a bivariate geometric Brownian motion. If the state-price process is multiplicatively separable into time and endowment functions, our main result shows that firm (endowment) price volatility is stochastic (state-dependent) if, and only if, the endowment function is not a power function. In a pure exchange economy populated by two agents with constant relative risk aversion (CRRA) preferences we confirm the separability, and we show furthermore that firm (endowment) price volatility is stochastic (state-dependent) if, and only if, both agents are heterogeneous in risk-preferences.

Keywords: stochastic volatility, state-dependent volatility, heterogeneity

JEL Classification: G13

Suggested Citation

Leisen, Dietmar P. J., Heterogeneity in Risk Preferences Leads to Stochastic Volatility (June 21, 2018). Available at SSRN: https://ssrn.com/abstract=3200297 or http://dx.doi.org/10.2139/ssrn.3200297

Dietmar P. J. Leisen (Contact Author)

Johannes Gutenberg University Mainz - Department of Banking ( email )

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