Disasterization: A Simple Way to Fix the Asset Pricing Properties of Macroeconomic Models
Gabaix, Xavier. 2011. "Disasterization: A Simple Way to Fix the Asset Pricing Properties of Macroeconomic Models."
American Economic Review,
A central difficulty in economics is to create a model with both good business cycle properties and asset pricing properties. I show how to solve this difficulty by a simple portable modeling device: the "disasterization" of models. Take an economy with good business cycle properties and create a new, "disasterized" economy, which is essentially identical to the original one except that disasters can destroy part of the capital stock and productivity. In such a disasterized economy, asset prices exhibit high and volatile risk premia, but macro variables remain unchanged. Perturbations of this benchmark allow for feedback from finance to macro.
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Gabaix, Xavier (NYU)
E32: Business Fluctuations; Cycles
E44: Financial Markets and the Macroeconomy
G12: Asset Pricing; Trading volume; Bond Interest Rates