Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/203267 
Year of Publication: 
2014
Series/Report no.: 
SAFE Working Paper No. 11
Version Description: 
This version: October 13, 2014
Publisher: 
Goethe University Frankfurt, SAFE - Sustainable Architecture for Finance in Europe, Frankfurt a. M.
Abstract: 
There has been a considerable debate whether disaster models like Barro (2006) can rationalize the equity premium puzzle. This is because empirically disasters are not single extreme events, but tend to be long-lasting periods in which moderate negative consumption growth realizations cluster. Our paper proposes a novel way to explain this stylized fact. By allowing for consumption drops that can spark an economic crisis, we introduce a new economic channel that combines long-run and short-run risk. First, we document that our model can match consumption data of several countries. Second, we show that in a model with recursive preferences our new channel generates a large equity risk premium even if the consumption drops are assumed to be of moderate size.
Subjects: 
General Equilibrium
Asset Pricing
Recursive Preferences
Long-run Risk
Short-run Risk
JEL: 
G01
G12
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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