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Asset pricing with long-run disaster risk

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  • Rujie Fan
  • Chao Xiao

Abstract

Traditional disaster models with time-varying disaster risk are not perfect in explaining asset returns. We redefine rare economic disasters and develop a novel disaster model with long-run disaster risk to match the asset return moments observed in the U.S. data. The difference from traditional disaster models is that our model contains the long-run disaster risk by treating the long-run ingredient of consumption growth as a function of time-varying disaster probability. Our model matches the U.S. data better than the traditional disaster model with time-varying disaster risk. This study uncovers an additional channel through which disaster risk affects asset returns and bridges the gap between long-run risk models and rare disaster models.

Suggested Citation

  • Rujie Fan & Chao Xiao, 2023. "Asset pricing with long-run disaster risk," PLOS ONE, Public Library of Science, vol. 18(6), pages 1-21, June.
    • Handle: RePEc:plo:pone00:0287687
    DOI: 10.1371/journal.pone.0287687
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