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Disasterization: A Simple Way to Fix the Asset Pricing Properties of Macroeconomic Models

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  • Xavier Gabaix

Abstract

A central difficulty in economics is to create a model with both good business cycle properties and asset pricing properties. I show how to solve this difficulty by a simple portable modeling device: the "disasterization" of models. Take an economy with good business cycle properties and create a new, "disasterized" economy, which is essentially identical to the original one except that disasters can destroy part of the capital stock and productivity. In such a disasterized economy, asset prices exhibit high and volatile risk premia, but macro variables remain unchanged. Perturbations of this benchmark allow for feedback from finance to macro.

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/aer.101.3.406
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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 101 (2011)
Issue (Month): 3 (May)
Pages: 406-09

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Handle: RePEc:aea:aecrev:v:101:y:2011:i:3:p:406-09

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  1. Xavier Gabaix, 2012. "Variable Rare Disasters: An Exactly Solved Framework for Ten Puzzles in Macro-Finance," The Quarterly Journal of Economics, Oxford University Press, vol. 127(2), pages 645-700.
  2. Thomas Tallarini, . "Risk-Sensitive Real Business Cycles," GSIA Working Papers 1997-35, Carnegie Mellon University, Tepper School of Business.
  3. Barro, Robert, 2006. "Rare Disasters and Asset Markets in the Twentieth Century," Scholarly Articles 3208215, Harvard University Department of Economics.
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