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Learning about Disaster Risk: Joint Implications for Consumption and Asset Prices

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  • Max Gillman
  • Michal Kejak
  • Michal Pakos

Abstract

Rietz (1988) and Barro (2006) subject consumption and dividends to rare disasters in the growth rate. We extend their framework and subject consumption and dividends to rare disasters in the growth persistence. Wemodel growth persistence by means of two hidden types of economic slowdowns: recessions and lost decades. We estimate the model based on the post-war U.S. data using maximum likelihood and find that it can simultaneously match a wide array of dynamic pricing phenomena in the equity and bond markets. The key intuition for our results stems from the inability to discriminate between the short and the long recessions ex ante.

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Bibliographic Info

Paper provided by The Center for Economic Research and Graduate Education - Economic Institute, Prague in its series CERGE-EI Working Papers with number wp507.

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Date of creation: Feb 2014
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Handle: RePEc:cer:papers:wp507

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Keywords: asset pricing; rare events; learning; stagnation; long-run risk; Peso problem;

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