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The Dynamics of Crises and the Equity Premium

Author

Listed:
  • Nicole Branger
  • Holger Kraft
  • Christoph Meinerding

Abstract

It is a major challenge for asset pricing models to generate a high equity premium and a low risk-free rate while imposing realistic consumption dynamics. To address this issue, our paper proposes a novel pricing channel: we allow for consumption drops that can spark an economic crisis. This new feature generates a large equity premium even if possible consumption drops are of moderate size. In turn, our model also matches the consumption data of 42 countries along several dimensions. In particular, our approach generates a realistic number of crises that have realistic durations and involve clustering of moderate consumption drops. Received October 17, 2014; accepted August 18, 2015 by Editor Pietro Veronesi.

Suggested Citation

  • Nicole Branger & Holger Kraft & Christoph Meinerding, 2016. "The Dynamics of Crises and the Equity Premium," The Review of Financial Studies, Society for Financial Studies, vol. 29(1), pages 232-270.
    • Handle: RePEc:oup:rfinst:v:29:y:2016:i:1:p:232-270.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhv057
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    Cited by:

    1. Fu, Qi & So, Jacky Yuk-Chow & Li, Xiaotong, 2024. "Stable paretian distribution, return generating processes and habit formation—The implication for equity premium puzzle," The North American Journal of Economics and Finance, Elsevier, vol. 70(C).
    2. Marfè, Roberto & Pénasse, Julien, 2024. "Measuring macroeconomic tail risk," Journal of Financial Economics, Elsevier, vol. 156(C).
    3. Branger, Nicole & Grüning, Patrick & Kraft, Holger & Meinerding, Christoph, 2013. "Asset pricing under uncertainty about shock propagation," SAFE Working Paper Series 34, Leibniz Institute for Financial Research SAFE.
    4. Ruan, Xinfeng, 2021. "Ambiguity, long-run risks, and asset prices in continuous time," International Review of Economics & Finance, Elsevier, vol. 71(C), pages 115-126.
    5. Ruan, Xinfeng & Zhang, Jin E., 2019. "Moment spreads in the energy market," Energy Economics, Elsevier, vol. 81(C), pages 598-609.
    6. Ilya Dergunov & Christoph Meinerding & Christian Schlag, 2023. "Extreme Inflation and Time-Varying Expected Consumption Growth," Management Science, INFORMS, vol. 69(5), pages 2972-3002, May.
    7. Christoph Meinerding, 2012. "Asset Allocation And Asset Pricing In The Face Of Systemic Risk: A Literature Overview And Assessment," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 15(03), pages 1-27.
    8. Jin E. Zhang & Eric C. Chang & Huimin Zhao, 2020. "Market Excess Returns, Variance and the Third Cumulant," International Review of Finance, International Review of Finance Ltd., vol. 20(3), pages 605-637, September.
    9. David Alaminos & Ignacio Esteban & M. Belén Salas, 2023. "Neural networks for estimating Macro Asset Pricing model in football clubs," Intelligent Systems in Accounting, Finance and Management, John Wiley & Sons, Ltd., vol. 30(2), pages 57-75, April.
    10. Rick Van der Ploeg & Christoph Hambel & Holger Kraft, 2020. "Asset Pricing and Decarbonization: Diversification versus Climate Action," Economics Series Working Papers 901, University of Oxford, Department of Economics.
    11. Dergunov, Ilya & Meinerding, Christoph & Schlag, Christian, 2019. "Extreme inflation and time-varying consumption growth," Discussion Papers 16/2019, Deutsche Bundesbank.
    12. Ruan, Xinfeng & Zhang, Jin E., 2021. "Ambiguity on uncertainty and the equity premium," Finance Research Letters, Elsevier, vol. 38(C).
    13. Zhao, Yang & Yao, Yuan & Wang, Mingtao, 2024. "Risk-free rate puzzle: An explanation of the heterogeneity of consumer risk attitudes under China's income gap," International Review of Economics & Finance, Elsevier, vol. 89(PB), pages 940-960.
    14. Christoph Hambel & Holger Kraft & Frederick van der Ploeg, 2024. "Asset Diversification Versus Climate Action," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 65(3), pages 1323-1355, August.
    15. Chibane, Messaoud & Poncet, Patrice, 2025. "Housing rare disaster events and asset prices," Economic Modelling, Elsevier, vol. 147(C).
    16. Kroencke, Tim A., 2022. "Recessions and the stock market," Journal of Monetary Economics, Elsevier, vol. 131(C), pages 61-77.

    More about this item

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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