Rare Disasters and Asset Markets in the Twentieth Century
The potential for rare economic disasters explains a lot of asset-pricing puzzles. I calibrate disaster probabilities from the twentieth century global history, especially the sharp contractions associated with World War I, the Great Depression, and World War II. The puzzles that can be explained include the high equity premium, low risk-free rate, and volatile stock returns. Another mystery that may be resolved is why expected real interest rates were low in the United States during major wars, such as World War II. The model, an extension of work by Rietz, maintains the tractable framework of a representative agent, time-additive and isoelastic preferences, and complete markets. The results hold with i.i.d. shocks to productivity growth in a Lucas-tree type economy and also with the inclusion of capital formation.
|Date of creation:||2006|
|Publication status:||Published in The Quarterly Journal of Economics|
|Contact details of provider:|| Postal: Littauer Center, Cambridge, MA 02138|
Web page: http://www.economics.harvard.edu/
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- Mehra, Rajnish & Prescott, Edward C., 1985.
"The equity premium: A puzzle,"
Journal of Monetary Economics,
Elsevier, vol. 15(2), pages 145-161, March.
- R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
- Joel Slemrod, 1986. "Saving and the Fear of Nuclear War," Journal of Conflict Resolution, Peace Science Society (International), vol. 30(3), pages 403-419, September.
- John W. Kendrick, 1961. "Productivity Trends in the United States," NBER Books, National Bureau of Economic Research, Inc, number kend61-1, October.
- Mehra, Rajnish & Prescott, Edward C., 1988. "The equity risk premium: A solution?," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 133-136, July. Full references (including those not matched with items on IDEAS)
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