Research Publication

March 2017

Stochastic Compounding and Uncertain Valuation

Lars Peter Hansen and Jose A. Scheinkman

Exploring long-term implications of valuation leads us to recover and use a distorted probability measure that reflects the long-term implications for risk pricing. This measure is typically distinct from the physical and the risk neutral measures that are well known in mathematical finance. We apply a generalized version of Perron-Frobenius theory to construct this probability measure and present several applications. We employ Perron-Frobenius methods to i) explore the observational implications of risk adjustments and investor beliefs as reflected in asset market data; ii) catalog alternative forms of misspecification of parametric valuation models; and iii) characterize how long-term components of growth-rate risk impact investor preferences implied by Kreps-Porteus style utility recursions.

Pages: 21-50|Title of book: After the Flood: How the Great Recession Changed Economic Thought |Publisher: The University of Chicago Press |Tags: Uncertainty and Valuation|Export BibTeX >

@incollection{hansenscheinkman:2017,
Author = {Hansen, Lars Peter and Scheinkman, Jose},
Booktitle = {After The Flood},
Pages = {21-50},
Publisher = {The University of Chicago Press},
Title = {Stochastic Compounding and Uncertain Valuation},
Year = {2017}}