A Multi Period Equilibrium Pricing Model

Abstract

We propose an equilibrium pricing model in a dynamic multiperiod stochastic framework with uncertain income. There are one tradable risky asset (stock/commodity), one nontradable underlying (temperature), and also a contingent claim (weather derivative) written on the tradable risky asset and the nontradable underlying in the market. The price of the contingent claim is priced in equilibrium by optimal strategies of representative agent and market clearing condition. The risk preferences are of exponential type with a stochastic coefficient of risk aversion. Both subgame perfect strategy and naive strategy are considered and the corresponding equilibrium prices are derived. From the numerical result we examine how the equilibrium prices vary in response to changes in model parameters and highlight the importance of our equilibrium pricing principle.

Multi-Period Investment Strategies under Cumulative Prospect Theory

“…The optimal strategy is computed by backward induction (see e.g. [18] and [21] for similar techniques). Our main result is a recursive formula to characterize the optimal strategies.…”