IDEAS home Printed from https://ideas.repec.org/a/eee/reveco/v89y2024ipap845-854.html
   My bibliography  Save this article

Overextrapolation of disaster probabilities and asset pricing in a production economy

Author

Listed:
  • Gao, Han
  • Lin, Chunpeng
  • Peng, Juan
  • Zhao, Siqi

Abstract

In this paper, the overextrapolation belief about the jump intensity of disaster risk is incorporated into an equilibrium asset pricing model in a production economy. The theoretical results, which are dependent on the level of the jump intensity, show that overextrapolation may induce over/underinvestment and under/overconsumption. Moreover, it is predicted that the overextrapolative agent will always overreact on investment and consumption, which results in higher volatility in the economy and generates a higher equity risk premium under the equilibrium model. However, the effects of overextrapolation on the interest rate are ambiguous. Finally, we find that the overextrapolative agent suffers significant welfare loss due to the distortion of investment and consumption, especially when the jump intensity is far from the long-run mean.

Suggested Citation

  • Gao, Han & Lin, Chunpeng & Peng, Juan & Zhao, Siqi, 2024. "Overextrapolation of disaster probabilities and asset pricing in a production economy," International Review of Economics & Finance, Elsevier, vol. 89(PA), pages 845-854.
    • Handle: RePEc:eee:reveco:v:89:y:2024:i:pa:p:845-854
    DOI: 10.1016/j.iref.2023.07.078
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S1059056023002897
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.iref.2023.07.078?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    More about this item

    Keywords

    Overextrapolation; Disaster probabilities; Investment; Asset pricing; Welfare loss;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:reveco:v:89:y:2024:i:pa:p:845-854. See general information about how to correct material in RePEc.

    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.

    We have no bibliographic references for this item. You can help adding them by using 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 RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/inca/620165 .

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

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.