Working Paper: NBER ID: w12797
Authors: Laurent E. Calvet; Adlai J. Fisher
Abstract: 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: equilibrium valuation; endogenous jumps; asset pricing; multifractal jump-diffusion
JEL Codes: C5; D53; G0; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Equilibrium valuation (G19) | endogenous jumps in asset prices (G19) |
| Persistence of volatility shocks (E32) | size of price jumps (E30) |
| volatility shocks (E32) | price jumps (D49) |
| dynamics of volatility and consumption (D11) | price jumps (D49) |
| State vector switches (C32) | priced jumps in equilibrium (D41) |
| Number of frequencies driving fundamentals (C69) | price process converging to multifractal jump-diffusion (C69) |