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Time-varying rare disaster risk and stock returns

Author

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  • Berkman, Henk
  • Jacobsen, Ben
  • Lee, John B.

Abstract

This study provides empirical support for theoretical models that allow for time-varying rare disaster risk. Using a database of 447 international political crises during the period 1918-2006, we create a crisis index that shows substantial variation over time. Changes in this crisis index, our proxy for changes in perceived disaster probability, have a large impact on both the mean and volatility of world stock market returns. Crisis risk is positively correlated with the earnings-price ratio and the dividend yield. Cross-sectional tests also show that crisis risk is priced: Industries that are more crisis risk sensitive yield higher returns.

Suggested Citation

  • 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.
  • Handle: RePEc:eee:jfinec:v:101:y:2011:i:2:p:313-332
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