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Rare Booms and Disasters in a Multi-sector Endowment Economy

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  • Jerry Tsai
  • Jessica A. Wachter

Abstract

Why do value stocks have higher expected returns than growth stocks, in spite of having lower risk? Why do these stocks exhibit positive abnormal performance while growth stocks exhibit negative abnormal performance? This paper offers a rare-events based explanation that can also account for the high equity premium and volatility of the aggregate market. The model explains other puzzling aspects of the data such as joint patterns in time series predictablity of aggregate market and value and growth returns, long periods in which growth outperforms value, and the association between directional covariance and skewness and low realized returns.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 20062.

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Date of creation: Apr 2014
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Handle: RePEc:nbr:nberwo:20062

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