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The Time-Varying Risk of Macroeconomic Disasters

Listed author(s):
  • Roberto Marfè
  • Julien Penasse

While time-varying disasters can explain many characteristics of financial markets, their quantitative assessment is still missing. We propose a latent variable approach to estimate the time-varying probability of a macroeconomic disaster, using a dataset of 42 countries over more than 100 years. We find that disaster risk is volatile and persistent, strongly correlates with the dividend yield, and forecasts stock returns. A state-of-the-art model calibrated with our disaster risk estimates generates a large and volatile equity premium and a low risk free rate under standard assumptions. This evidence supports the idea that investors' fear of disasters drives equity premium dynamics.

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File URL: http://www.carloalberto.org/assets/working-papers/no.463.pdf
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Paper provided by Collegio Carlo Alberto in its series Carlo Alberto Notebooks with number 463.

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Length: pages 46
Date of creation: 2016
Handle: RePEc:cca:wpaper:463
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