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Rare Booms and Disasters in a Multi-sector Endowment Economy

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  • Jerry Tsai
  • Jessica A. Wachter

Abstract

Why do value stocks have higher average returns than growth stocks, despite having lower risk? Why do these stocks exhibit positive abnormal performance while growth stocks exhibit negative abnormal performance? This paper offers a rare-events based explanation that can also account for the high equity premium and volatility of the aggregate market. The model explains other puzzling aspects of the data such as joint patterns in time series predictablity of aggregate market and value and growth returns, long periods in which growth outperforms value, and the association between positive skewness and low realized returns.

Suggested Citation

  • Jerry Tsai & Jessica A. Wachter, 2014. "Rare Booms and Disasters in a Multi-sector Endowment Economy," NBER Working Papers 20062, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:20062 Note: AP
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    Cited by:

    1. Riccardo Colacito & Eric Ghysels & Jinghan Meng & Wasin Siwasarit, 2016. "Skewness in Expected Macro Fundamentals and the Predictability of Equity Returns: Evidence and Theory," Review of Financial Studies, Society for Financial Studies, vol. 29(8), pages 2069-2109.
    2. Jerry Tsai & Jessica A. Wachter, 2015. "Disaster Risk and its Implications for Asset Pricing," NBER Working Papers 20926, National Bureau of Economic Research, Inc.
    3. Larry G. Epstein & Emmanuel Farhi & Tomasz Strzalecki, 2014. "How Much Would You Pay to Resolve Long-Run Risk?," American Economic Review, American Economic Association, vol. 104(9), pages 2680-2697, September.
    4. Max Gillman & Michal Kejak & Michal Pakoš, 2015. "Learning about Rare Disasters: Implications For Consumption and Asset Prices," Review of Finance, European Finance Association, vol. 19(3), pages 1053-1104.
    5. De Rezende, Rafael B., 2015. "Risks in macroeconomic fundamentals and excess bond returns predictability," Working Paper Series 295, Sveriges Riksbank (Central Bank of Sweden).
    6. Max Gillman & Michal Kejak & Michal Pakos, 2014. "Learning about Rare Disasters: Implications For Consumption and Asset Prices," Working Papers 1002, University of Missouri-St. Louis, Department of Economics.
    7. Max Gillman & Michal Kejak & Michal Pakos, 2014. "Learning about Disaster Risk: Joint Implications for Consumption and Asset Prices," CERGE-EI Working Papers wp507, The Center for Economic Research and Graduate Education - Economics Institute, Prague.

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    JEL classification:

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

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