Pricing growth-rate risk

We characterize the compensation demanded by investors in equilibrium for incremental exposure to growth-rate risk. Given an underlying Markov diffusion that governs the state variables in the economy, the economic model implies a stochastic discount factor process S and a reference stochastic growth process G for the macroeconomy. Both are modeled conveniently as multiplicative functionals of a multidimensional Brownian motion. To study pricing we consider the pricing implications of parameterized family of growth processes G , with G0 = G, as is made small. This parameterization defines a direction of growth-rate risk exposure that is priced using the stochastic discount factor S. By changing the investment horizon we trace a term structure of risk prices that shows how the valuation of risky cash flows depends on the investment horizon. Using methods of Hansen and Scheinkman (2009), we characterize the limiting behavior of the risk prices as the investment horizon is made arbitrarily long.