An equilibrium asset pricing model based on Lévy processes: Relations to stochastic volatility, and the survival hypothesis (Q5938035)

A new model of asset returns is considered. The spot prices of assets are modelled as exponentials of Lévy processes, which have normal inverse Gaussian marginals, while the aggregate consumptions is inverse Gaussian. The model is incomplete, therefore contingent claims are priced basing on the equilibrium principle rather than the arbitrage theory, and it is done in such a way that the price does not contain the preference parameters. The pricing formula is compared to the corresponding result of stochastic volatility models in the arbitrage valuation theory. A consumption-based capital asset pricing model is derived and calibrated to the data from \textit{R. Mehra} and \textit{E. Prescott} [J. Monetary Econ. 15, 145-161 (1985)]. The model contains just the right number of parameters to fit the data and thus gives a possible resolution of the equity premium puzzle. The survival hypothesis of \textit{Brown} et al. [J. Finance 50, 853-873 (1995)] is also investigated within this model, giving a crash probability of the market of \(0.05\%\) over the 100-year period of the NYSE, a value somewhat smaller than conjectured by Brown et al.