We propose a novel time-changed Lévy LIBOR (London Interbank Offered Rate) market model for jointly pricing of caps and swaptions. The time changes are split into three components. The first component allows matching the volatility term structure, the second generates stochastic volatility, and the third accommodates for stochastic skew. The parsimonious model is flexible enough to accommodate the behavior of both caps and swaptions. For the joint estimation we use a comprehensive data set spanning the financial crisis of 2007–2010. We find that, even during this period, neither market is as fragmented as suggested by the previous literature.

We investigate the implications of technological innovation and non-diversifiable risk on entrepreneurial entry and optimal portfolio choice. In a real options model where two risk-averse individuals strategically decide on technology adoption, we show that the impact of non-diversifiable risk on the option timing decision is ambiguous and depends on the frequency of technological change. Compared to the complete market case, non-diversifiable risk may accelerate or delay the optimal investment decision. Moreover, strategic considerations regarding technology adoption play a central role for the entrepreneur’s optimal portfolio choice in the presence of non-diversifiable risk.

We argue that incentives to take equity risk (”equity incentives”) only partially capture incentives to take asset risk (“asset incentives”). This is because leverage, while central to the theory of risk-shifting, is not explicitly considered by equity incentives. Employing measures of asset incentives that account for leverage, we find that asset risk-taking incentives can be large compared to incentives to increase firm value. Stock holdings can induce substantial risk-taking incentives, contrary to the assumption that only stock options drive risk-taking. Finally, asset incentives help explain asset risk-taking of U.S. financial institutions before the 2007/08 crisis.