Stochastic Volatility and Asset Pricing Puzzles
64 Pages Posted: 14 Aug 2018
Date Written: January 29, 2018
This paper builds a real-options model of the firm with stochastic volatility to shed new light on the value premium, financial distress, and credit spread puzzles. Since the equity of growth firms and financially distressed firms have embedded options, such securities hedge against volatility risk and command lower volatility risk premia than the equities of value or financially healthy firms. Conversely, corporate debt will tend to command large volatility risk premia, allowing the model to generate higher credit spreads than existing structural models. The paper develops a novel methodology based on asymptotic expansions to solve the model.
Keywords: Asset Pricing, Real Options, Stochastic Volatility
JEL Classification: G12, G13
Suggested Citation: Suggested Citation