Working Paper

Disaster Risk and Asset Returns : An International Perspective


Abstract: Recent studies have shown that disaster risk can generate asset return moments similar to those observed in the U.S. data. However, these studies have ignored the cross-country asset pricing implications of the disaster risk model. This paper shows that standard U.S.-based disaster risk model assumptions found in the literature lead to counterfactual international asset pricing implications. Given consumption pricing moments, disaster risk cannot explain the range of equity premia and government bill rates nor the high degree of equity return correlation found in the data. Moreover, the independence of disasters presumed in some studies generates counterfactually low cross-country correlations in equity markets. Alternatively, if disasters are all shared, the model generates correlations that are excessively high. We show that common and idiosyncratic components of disaster risk are needed to explain the pattern in consumption and equity co-movements.

Keywords: Rare disaster; Asset returns; International correlations;

JEL Classification: F3; F4; G1;

https://doi.org/10.17016/IFDP.2017.1199

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Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: International Finance Discussion Papers

Publication Date: 2017-02

Number: 1199

Pages: 76 pages