Multifrequency Jump-Diffusions: An Equilibrium Approach
35 Pages Posted: 20 Dec 2006 Last revised: 7 May 2013
Date Written: January 1, 2008
This paper proposes that equilibrium valuation is a powerful method to generate endogenous jumps in asset prices, which provides a structural alternative to traditional reduced-form specifications with exogenous discontinuities. We specify an economy with continuous consumption and dividend paths, in which endogenous price jumps originate from the market impact of regime-switches in the drifts and volatilities of fundamentals. We parsimoniously incorporate shocks of heterogeneous durations in consumption and dividends while keeping constant the number of parameters. Equilibrium valuation creates an endogenous relation between a shock's persistence and the magnitude of the induced price jump. As the number of frequencies driving fundamentals goes to infinity, the price process converges to a novel stochastic process, which we call a multifractal jump-diffusion.
Keywords: Endogenous jumps, general equilibrium, Markov regime-switching, multifrequency, fat tails, stochastic volatility, time deformation, volatility component
JEL Classification: G0, C5
Suggested Citation: Suggested Citation