Advanced Search
MyIDEAS: Login

Disasters Risk and Business Cycles

Contents:

Author Info

  • François Gourio

Abstract

To construct a business cycle model consistent with the observed behavior of asset prices, and study the effect of shocks to aggregate uncertainty, I introduce a small, time-varying risk of economic disaster in a standard real business cycle model. The paper establishes two simple theoretical results: first, when the probability of disaster is constant, the risk of disaster does not affect the path of macroeconomic aggregates - a "separation theorem" between macroeconomic quantities and asset prices in the spirit of Tallarini (2000). Second, shocks to the probability of disaster, which generate variation in risk premia over time, are observationally equivalent to preference shocks. An increase in the perceived probability of disaster leads to a collapse of investment and a recession, an increase in risk spreads, and a decrease in the yield on safe assets. To assess the empirical validity of the model, I infer the probability of disaster from observed asset prices and feed it into the model. The variation over time in this probability appears to account for a significant fraction of business cycle dynamics, especially sharp downturns in investment and output such as 2008-IV.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.nber.org/papers/w15399.pdf
Download Restriction: no

Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15399.

as in new window
Length:
Date of creation: Oct 2009
Date of revision:
Publication status: published as Francois Gourio, 2012. "Disaster Risk and Business Cycles," American Economic Review, American Economic Association, vol. 102(6), pages 2734-66, October.
Handle: RePEc:nbr:nberwo:15399

Note: AP EFG ME
Contact details of provider:
Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
Phone: 617-868-3900
Email:
Web page: http://www.nber.org
More information through EDIRC

Related research

Keywords:

Other versions of this item:

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Enrique G. Mendoza, 2010. "Sudden Stops, Financial Crises, and Leverage," American Economic Review, American Economic Association, vol. 100(5), pages 1941-66, December.
  2. Susanto Basu & Brent Bundick, 2012. "Uncertainty Shocks in a Model of Effective Demand," NBER Working Papers 18420, National Bureau of Economic Research, Inc.
  3. Jermann, Urban J., 1998. "Asset pricing in production economies," Journal of Monetary Economics, Elsevier, vol. 41(2), pages 257-275, April.
  4. Rudebusch, Glenn D. & Swanson, Eric T., 2008. "Examining the bond premium puzzle with a DSGE model," Journal of Monetary Economics, Elsevier, vol. 55(Supplemen), pages S111-S126, October.
  5. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  6. Dieckmann, Stephan & Gallmeyer, Michael, 2005. "The equilibrium allocation of diffusive and jump risks with heterogeneous agents," Journal of Economic Dynamics and Control, Elsevier, vol. 29(9), pages 1547-1576, September.
  7. François Gourio, 2008. "Time-series predictability in the disaster model," Boston University - Department of Economics - Working Papers Series wp2008-016, Boston University - Department of Economics.
  8. Claudio Campanale & Rui Castro & Gian Luca Clementi, 2007. "Asset Pricing in a Production Economy with Chew-Dekel Preferences," Working Papers 07-13, New York University, Leonard N. Stern School of Business, Department of Economics.
  9. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July.
  10. G. William Schwert, 1990. "Why Does Stock Market Volatility Change Over Time?," NBER Working Papers 2798, National Bureau of Economic Research, Inc.
  11. Anisha Ghosh & Christian Julliard, 2008. "Can Rare Events Explain the Equity Premium Puzzle?," 2008 Meeting Papers 1090, Society for Economic Dynamics.
  12. 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.
  13. Laura Xiaolei Liu & Toni M. Whited & Lu Zhang, 2009. "Investment-Based Expected Stock Returns," Journal of Political Economy, University of Chicago Press, vol. 117(6), pages 1105-1139, December.
  14. Robert F. Stambaugh, 1999. "Predictive Regressions," NBER Technical Working Papers 0240, National Bureau of Economic Research, Inc.
  15. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2008. "New Keynesian models: not yet useful for policy analysis," Staff Report 409, Federal Reserve Bank of Minneapolis.
  16. Jesus Fernandez-Villaverde & Pablo Guerron-Quintana & Juan F. Rubio-Ramírez & Martin Uribe, 2009. "Risk Matters: The Real Effects of Volatility Shocks," PIER Working Paper Archive 09-013, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  17. Beaudry, Paul & Portier, Franck, 2003. "Stock Prices, News and Economic Fluctuations," CEPR Discussion Papers 3844, C.E.P.R. Discussion Papers.
  18. Fama, Eugene F. & French, Kenneth R., 1989. "Business conditions and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 25(1), pages 23-49, November.
  19. Stanley E. Zin & Bryan R. Routledge & David K. Backus, 2009. "The Cyclical Component of US Asset Returns," 2009 Meeting Papers 13, Society for Economic Dynamics.
  20. Andrew Ang & Geert Bekaert, 2001. "Stock Return Predictability: Is it There?," NBER Working Papers 8207, National Bureau of Economic Research, Inc.
  21. Francesco Furlanetto & Martin Seneca, 2011. "New perspectives on depreciation shocks as a source of business cycle fluctuations," Working Paper 2011/02, Norges Bank.
  22. Campbell, John & Yogo, Motohiro, 2006. "Efficient tests of stock return predictability," Scholarly Articles 3122601, Harvard University Department of Economics.
  23. Larry E. Jones & Rodolfo E. Manuelli & Henry E. Siu, 2005. "Fluctuations in Convex Models of Endogenous Growth II: Business Cycle Properties," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(4), pages 805-828, October.
  24. John Y. Campbell & John H. Cochrane, 1994. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," CRSP working papers 412, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  25. Schwert, G William, 1990. " Stock Returns and Real Activity: A Century of Evidence," Journal of Finance, American Finance Association, vol. 45(4), pages 1237-57, September.
  26. Timothy Kehoe & Edward Prescott, 2002. "Data Appendix to Great Depressions of the Twentieth Century," Technical Appendices kehoe02, Review of Economic Dynamics.
  27. Ferson, Wayne E & Harvey, Campbell R, 1991. "The Variation of Economic Risk Premiums," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 385-415, April.
  28. Rietz, Thomas A., 1988. "The equity risk premium a solution," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 117-131, July.
  29. Jessica Wachter, 2008. "Can time-varying risk of rare disasters explain aggregate stock market volatility?," 2008 Meeting Papers 944, Society for Economic Dynamics.
  30. Barro, Robert, 2006. "Rare Disasters and Asset Markets in the Twentieth Century," Scholarly Articles 3208215, Harvard University Department of Economics.
  31. Francis Longstaff & Monika Piazzesi, 2003. "Corporate Earnings and the Equity Premium," NBER Working Papers 10054, National Bureau of Economic Research, Inc.
  32. Andrew B. Abel, 1998. "Risk Premia and Term Premia in General Equilibrium," NBER Working Papers 6683, National Bureau of Economic Research, Inc.
  33. Annette Vissing-Jorgensen, 2002. "Limited Asset Market Participation and the Elasticity of Intertemporal Substitution," NBER Working Papers 8896, National Bureau of Economic Research, Inc.
  34. Michele Boldrin & Lawrence J. Christiano & Jonas D.M. Fisher, 1999. "Habit persistence, asset returns and the business cycles," Working Paper Series WP-99-14, Federal Reserve Bank of Chicago.
  35. Simon Gilchrist & Fabio M. Natalucci & Egon Zakrajsek, 2007. "Investment and the Cost of Capital: New Evidence from the Corporate Bond Market," Boston University - Department of Economics - Working Papers Series WP2007-027, Boston University - Department of Economics.
  36. Robert E. Lucas Jr., 2003. "Macroeconomic Priorities," American Economic Review, American Economic Association, vol. 93(1), pages 1-14, March.
  37. Georg Kaltenbrunner & Lars A. Lochstoer, 2010. "Long-Run Risk through Consumption Smoothing," Review of Financial Studies, Society for Financial Studies, vol. 23(8), pages 3190-3224, August.
  38. TallariniJr., Thomas D., 2000. "Risk-sensitive real business cycles," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 507-532, June.
  39. Jaccard, Ivan, 2010. "Asset pricing, habit memory, and the labor market," Working Paper Series 1163, European Central Bank.
  40. Ely�s Jouini & Clotilde Napp, 2007. "Consensus Consumer and Intertemporal Asset Pricing with Heterogeneous Beliefs," Review of Economic Studies, Oxford University Press, vol. 74(4), pages 1149-1174.
  41. Nicholas Bloom, 2009. "The Impact of Uncertainty Shocks," Econometrica, Econometric Society, vol. 77(3), pages 623-685, 05.
  42. Francois Gourio, 2008. "Disasters and Recoveries," American Economic Review, American Economic Association, vol. 98(2), pages 68-73, May.
  43. Marianne Baxter & Robert G. King, 1999. "Measuring Business Cycles: Approximate Band-Pass Filters For Economic Time Series," The Review of Economics and Statistics, MIT Press, vol. 81(4), pages 575-593, November.
  44. Ian Martin, 2010. "Consumption-Based Asset Pricing with Higher Cumulants," NBER Working Papers 16153, National Bureau of Economic Research, Inc.
  45. Wen Yao & Juan Rubio Ramirez & Jesus Fernandez Villaverde & Dario Caldara, 2009. "Computing Models with Recursive Preferences," 2009 Meeting Papers 1162, Society for Economic Dynamics.
  46. Lawrence J. Christiano & Martin Eichenbaum & Sergio Rebelo, 2010. "When is the government spending multiplier large?," CQER Working Paper 2010-01, Federal Reserve Bank of Atlanta.
  47. Georg Kaltenbrunner & Lars Lochstoer, 2007. "Long-Run Risk through Consumption Smoothing," 2007 Meeting Papers 25, Society for Economic Dynamics.
  48. Lettau, Martin & Ludvigson, Sydney, 2001. "Time-Varying Risk Premia and the Cost of Capital: An Alternative Implication of the Q Theory of Investment," CEPR Discussion Papers 3103, C.E.P.R. Discussion Papers.
  49. Jose Ursua & Jon Steinsson & Emi Nakamura & Robert Barro, 2008. "Crises and Recoveries in an Empirical Model of Consumption Disasters," 2008 Meeting Papers 1089, Society for Economic Dynamics.
  50. Jouini, Elyès & Napp, Clotilde, 2007. "Consensus Consumer and Intertemporal Asset Pricing with Heterogeneous Beliefs," Economics Papers from University Paris Dauphine 123456789/78, Paris Dauphine University.
  51. Glenn Rudebusch & Eric Swanson, 2008. "The bond premium in a DSGE model with long-run real and nominal risks," Working Paper Series 2008-31, Federal Reserve Bank of San Francisco.
  52. Sandmo, Agnar, 1970. "The Effect of Uncertainty on Saving Decisions," Review of Economic Studies, Wiley Blackwell, vol. 37(3), pages 353-60, July.
  53. Dario Caldara & Jesús Fernández-Villaverde & Juan F. Rubio-Ramírez & Wen Yao, 2009. "Computing DSGE Models with Recursive Preferences," NBER Working Papers 15026, National Bureau of Economic Research, Inc.
  54. John Y. Campbell, 1998. "Asset Prices, Consumption, and the Business Cycle," NBER Working Papers 6485, National Bureau of Economic Research, Inc.
  55. Christian Julliard & Anisha Ghosh, 2008. "Can rare events explain the equity premium puzzle?," LSE Research Online Documents on Economics 4808, London School of Economics and Political Science, LSE Library.
  56. Berkman, Henk & Jacobsen, Ben & Lee, John B., 2011. "Time-varying rare disaster risk and stock returns," Journal of Financial Economics, Elsevier, vol. 101(2), pages 313-332, August.
  57. Hall, Robert E, 1988. "Intertemporal Substitution in Consumption," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 339-57, April.
  58. Emmanuel Farhi, 2008. "Rare Disasters and Exchange Rates," 2008 Meeting Papers 47, Society for Economic Dynamics.
  59. Claudio Campanale & Rui Castro & Gian Luca Clementi, 2010. "Asset Pricing in a Production Economy with Chew-Dekel Preferences," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 13(2), pages 379-402, April.
  60. Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1123-1175, 09.
  61. Mark Aguiar & Erik Hurst, 2005. "Consumption versus Expenditure," Journal of Political Economy, University of Chicago Press, vol. 113(5), pages 919-948, October.
  62. Amit Goyal & Ivo Welch, 2004. "A Comprehensive Look at the Empirical Performance of Equity Premium Prediction," Yale School of Management Working Papers amz2412, Yale School of Management, revised 01 Jan 2006.
  63. Gourio, François, 2011. "Putty-clay technology and stock market volatility," Journal of Monetary Economics, Elsevier, vol. 58(2), pages 117-131, March.
  64. Ravi Bansal & Amir Yaron, 2004. "Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles," Journal of Finance, American Finance Association, vol. 59(4), pages 1481-1509, 08.
  65. Aude Pommeret & Anne Epaulard, 2001. "Recursive Utility, Endogenous Growth, and the Welfare Cost of Volatility," IMF Working Papers 01/5, International Monetary Fund.
  66. George-Marios Angeletos, 2007. "Uninsured Idiosyncratic Investment Risk and Aggregate Saving," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 10(1), pages 1-30, January.
  67. Annette Vissing-Jorgensen, 2002. "Limited Asset Market Participation and the Elasticity of Intertemporal Substitution," Journal of Political Economy, University of Chicago Press, vol. 110(4), pages 825-853, August.
  68. Martin L. Weitzman, 2007. "Subjective Expectations and Asset-Return Puzzles," American Economic Review, American Economic Association, vol. 97(4), pages 1102-1130, September.
  69. Tom Krebs, 2003. "Human Capital Risk And Economic Growth," The Quarterly Journal of Economics, MIT Press, vol. 118(2), pages 709-744, May.
  70. Larry E. Jones & Rodolfo E. Manuelli & Henry E. Siu & Ennio Stacchetti, 2005. "Fluctuations in Convex Models of Endogenous Growth I: Growth Effects," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(4), pages 780-804, October.
  71. Jacob Boudoukh & Matthew Richardson & Robert F. Whitelaw, 2008. "The Myth of Long-Horizon Predictability," Review of Financial Studies, Society for Financial Studies, vol. 21(4), pages 1577-1605, July.
  72. Ralph S.J. Koijen & Jules H. van Binsbergen & Juan F. Rubio-Ramírez & Jesus Fernandez-Villaverde, 2008. "Likelihood Estimation of DSGE Models with Epstein-Zin Preferences," 2008 Meeting Papers 1099, Society for Economic Dynamics.
  73. Timothy J. Kehoe & Edward C. Prescott (), 2007. "Great depressions of the twentieth century," Monograph, Federal Reserve Bank of Minneapolis, number 2007gdott.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page.

Lists

This item is featured on the following reading lists or Wikipedia pages:
  1. Disaster Risk and Business Cycles (AER 2012) in ReplicationWiki

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:15399. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.