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Rare Macroeconomic Disasters

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  • Robert J. Barro

    ()
    ( Department of Economics, Harvard University, Cambridge, Massachusetts 02138)

  • José F. Ursúa

    ()
    ( Global Investment Research, Goldman Sachs, New York, NY 10282)

Abstract

The potential for rare macroeconomic disasters may explain an array of asset-pricing puzzles. Our empirical studies of these extreme events rely on long-term data now covering 28 countries for consumption and 40 for GDP. A baseline model calibrated with observed peak-to-trough disaster sizes accords with the average equity premium with a reasonable coefficient of relative risk aversion. High stock-price volatility can be explained by incorporating time-varying long-run growth rates and disaster probabilities. Business-cycle models with shocks to disaster probability have implications for the cyclical behavior of asset returns and corporate leverage, and international versions may explain the uncovered-interest-parity puzzle. Richer models of disaster dynamics allow for transitions between normalcy and disaster, bring in postcrisis recoveries, and use the full time series on consumption. Potential future research includes applications to long-term economic growth and environmental economics, and the use of stock-index options prices and other variables to gauge time-varying disaster probabilities.

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Bibliographic Info

Article provided by Annual Reviews in its journal Annual Review of Economics.

Volume (Year): 4 (2012)
Issue (Month): 1 (07)
Pages: 83-109

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Handle: RePEc:anr:reveco:v:4:y:2012:p:83-109

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Related research

Keywords: national accounts; rare disasters; disaster probability; fat tails; power-law distribution; equity premium; asset-pricing puzzles;

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References

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Citations

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Cited by:
  1. Aizenman, Joshua & Noy, Ilan, 2013. "Public and private saving and the long shadow of macroeconomic shocks," Working Paper Series 2776, Victoria University of Wellington, School of Economics and Finance.
  2. Joshua Aizenman & Ilan Noy, 2012. "Macroeconomic Adjustment and the History of Crises in Open Economies," NBER Working Papers 18527, National Bureau of Economic Research, Inc.
  3. Max Gillman & Michal Kejak & Michal Pakos, 2014. "Learning about Disaster Risk: Joint Implications for Consumption and Asset Prices," CERGE-EI Working Papers wp507, The Center for Economic Research and Graduate Education - Economic Institute, Prague.
  4. Salvador Pueyo, 2013. "Is it a power law distribution? The case of economic contractions," Papers 1310.2567, arXiv.org.
  5. Mehl, Arnaud, 2013. "Large global volatility shocks, equity markets and globalisation: 1885-2011," Working Paper Series 1548, European Central Bank.
  6. Max Gillman & Michal Kejak & Michal Pakos, 2014. "Learning about Rare Disasters: Implications for Consumptions and Asset Prices," CEU Working Papers 2014_2, Department of Economics, Central European University.
  7. Doukas, John A. & Zhang, Hao, 2013. "The performance of NDF carry trades," Journal of International Money and Finance, Elsevier, vol. 36(C), pages 172-190.

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