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Can time-varying risk of rare disasters explain aggregate stock market volatility?

  • Jessica Wachter

    (University of Pennsylvania)

not allow the probabilities of rare disasters to vary over time. Rather, Gabaix assumes that the degree of the response of dividends to a consumption disaster varies over time; it is this variability that drives volatility in his model. This sharply contrasts with the driving force of stock market volatility in this paper: the changing risk of a rare disaster.

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Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 944.

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Date of creation: 2008
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Handle: RePEc:red:sed008:944
Contact details of provider: Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
Fax: 1-314-444-8731
Web page: http://www.EconomicDynamics.org/society.htm
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  1. Sydney Ludvigson & Martin Lettau, 1999. "Consumption, aggregate wealth and expected stock returns," Staff Reports 77, Federal Reserve Bank of New York.
  2. John Y. Campbell, 2002. "Consumption-Based Asset Pricing," Harvard Institute of Economic Research Working Papers 1974, Harvard - Institute of Economic Research.
  3. Cochrane, John H, 1992. "Explaining the Variance of Price-Dividend Ratios," Review of Financial Studies, Society for Financial Studies, vol. 5(2), pages 243-80.
  4. Martin Lettau & Jessica A. Wachter, 2007. "Why Is Long-Horizon Equity Less Risky? A Duration-Based Explanation of the Value Premium," Journal of Finance, American Finance Association, vol. 62(1), pages 55-92, 02.
  5. Robert E. Hall, 1981. "Intertemporal Substitution in Consumption," NBER Working Papers 0720, National Bureau of Economic Research, Inc.
  6. Kreps, David M & Porteus, Evan L, 1978. "Temporal Resolution of Uncertainty and Dynamic Choice Theory," Econometrica, Econometric Society, vol. 46(1), pages 185-200, January.
  7. Itamar Drechsler & Amir Yaron, 2008. "What's Vol Got to Do With It," 2008 Meeting Papers 282, Society for Economic Dynamics.
  8. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March.
  9. Andrew B. Abel, 1998. "Risk Premia and Term Premia in General Equilibrium," NBER Working Papers 6683, National Bureau of Economic Research, Inc.
  10. Ian W. Martin, 2013. "Consumption-Based Asset Pricing with Higher Cumulants," Review of Economic Studies, Oxford University Press, vol. 80(2), pages 745-773.
  11. Robert J. Barro, 2007. "Rare Disasters, Asset Prices, and Welfare Costs," NBER Working Papers 13690, National Bureau of Economic Research, Inc.
  12. Keim, Donald B. & Stambaugh, Robert F., 1986. "Predicting returns in the stock and bond markets," Journal of Financial Economics, Elsevier, vol. 17(2), pages 357-390, December.
  13. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  14. Naik, Vasanttilak & Lee, Moon, 1990. "General Equilibrium Pricing of Options on the Market Portfolio with Discontinuous Returns," Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 493-521.
  15. Darrell Duffie & Jun Pan & Kenneth Singleton, 2000. "Transform Analysis and Asset Pricing for Affine Jump-Diffusions," Econometrica, Econometric Society, vol. 68(6), pages 1343-1376, November.
  16. Fran├žois Gourio, 2008. "Time-series predictability in the disaster model," Boston University - Department of Economics - Working Papers Series wp2008-016, Boston University - Department of Economics.
  17. Fama, Eugene F. & French, Kenneth R., 1989. "Business conditions and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 25(1), pages 23-49, November.
  18. Duffie, Darrell & Epstein, Larry G, 1992. "Asset Pricing with Stochastic Differential Utility," Review of Financial Studies, Society for Financial Studies, vol. 5(3), pages 411-36.
  19. Veronesi, Pietro, 2004. "The Peso problem hypothesis and stock market returns," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 707-725, January.
  20. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July.
  21. Hodrick, Robert J, 1992. "Dividend Yields and Expected Stock Returns: Alternative Procedures for Inference and Measurement," Review of Financial Studies, Society for Financial Studies, vol. 5(3), pages 357-86.
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