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Rare Events and Long-Run Risks

Author

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  • Robert Barro

    (Harvard University)

  • Tao Jin

    (Tsinghua University)

Abstract

Rare events (RE) and long-run risks (LRR) are complementary approaches for characterizing macroeconomic variables and understanding asset pricing. We estimate a model with RE and LRR using long-term consumption data for 42 economies, identify these two types of risks simultaneously from the data, and reveal their distinctions. RE typically associates with major historical episodes, such as world wars and depressions and analogous country-specific events. LRR reflects gradual processes that influence long-run growth rates and volatility. A match between the model and observed average rates of return on equity and short-term bonds requires a coefficient of relative risk aversion, γ, around 6. Most of the explanation for the equity premium derives from RE, although LRR makes a moderate contribution. However, LRR helps in fitting the Sharpe ratio. Generating good matches to the equity premium and Sharpe ratio simultaneously is still challenging. (Copyright: Elsevier)

Suggested Citation

  • Robert Barro & Tao Jin, 2021. "Rare Events and Long-Run Risks," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 39, pages 1-25, January.
  • Handle: RePEc:red:issued:18-485
    DOI: 10.1016/j.red.2020.08.002
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    2. Lorenzo Esposito & Giuseppe Mastromatteo, 2019. "Defaultnomics: Making Sense of the Barro-Ricardo Equivalence in a Financialized World," Economics Working Paper Archive wp_933, Levy Economics Institute.
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    More about this item

    Keywords

    Rare events; Long-run risks; Asset pricing; Risk aversion;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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