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Board of Governors of the Federal Reserve System (US)
Finance and Economics Discussion Series
Learning, Rare Disasters, and Asset Prices
In this paper, we examine how learning about disaster risk affects asset pricing in an endowment economy. We extend the literature on rare disasters by allowing for two sources of uncertainty: (1) the lack of historical data results in unknown parameters for the disaster process, and (2) the disaster takes time to unfold and is not directly observable. The model generates time variation in the risk premium through Bayesian updating of agents' beliefs regarding the likelihood and severity of disaster realization. The model accounts for the level and volatility of U.S. equity returns and generates predictability in returns.
Cite this item
Yang Lu & Michael Siemer, Learning, Rare Disasters, and Asset Prices, Board of Governors of the Federal Reserve System (US), Finance and Economics Discussion Series 2013-85, 01 Nov 2013.
- D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
- E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
Keywords: Rare disasters; Bayesian learning; equity premium puzzle; time-varying risk premia; return predictability
This item with handle RePEc:fip:fedgfe:2013-85
is also listed on EconPapers
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