Consumption-Based Asset Pricing with Rare Disaster Risk: A Simulated Method of Moments Approach

Konferenzbeitrag

The rare disaster hypothesis suggests that the extraordinarily high postwar U.S. equity premium resulted because investors ex ante demanded compensations for unlikely but calamitous risks that they happened not to incur. While convincing in theory, empirical tests of the rare disaster explanation are scarce. We estimate a disaster-including consumption-based asset pricing model (CBM) using a combination of the simulated method of moments and bootstrapping. We consider several methodological alternatives that differ in the moment matches and the way to account for disasters in the simulated consumption growth and return series. Whichever specification is used, the estimated preference parameters are of an economically plausible size, and the estimation precision is much higher than in previous studies that use the canonical CBM. A comparable combination of plausibility and estimation precision has not been delivered in the related literature. Our results thus provide empirical support for the rare disaster hypothesis, and help restore the nexus between real economy and financial markets implied by the consumption-based asset pricing paradigm.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Beiträge zur Jahrestagung des Vereins für Socialpolitik 2014: Evidenzbasierte Wirtschaftspolitik - Session: Financial Econometrics ; No. C12-V2

Classification and Topics

• Classification: Wirtschaft ; Financial Econometrics ; General Financial Markets: General (includes Measurement and Data) ; Asset Pricing; Trading Volume; Bond Interest Rates

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Grammig, Joachim ; Sönksen, Jantje
• Event: Veröffentlichung
• (who): ZBW - Deutsche Zentralbibliothek für Wirtschaftswissenschaften, Leibniz-Informationszentrum Wirtschaft
• (where): Kiel und Hamburg
• (when): 2014

Further information

• Handle: http://hdl.handle.net/10419/100614
• Last update: 10.03.2025, 11:41 AM CET