Asset Pricing With Disaster Risk
Saturday, Jan. 7, 2017 1:00 PM – 3:00 PM
- Chair: Francois Gourio, Federal Reserve Bank of Chicago
Learning, Rare Disasters, and Asset Prices
AbstractWe incorporate joint learning about state and parameter into a consumption-based asset pricing model with rare disasters. Agents are uncertain whether a negative shock signals the onset of a disaster or how much long-term damage a disaster will cause and they update their beliefs over time. The interaction of state and parameter uncertainty increases the total amount of uncertainty and slows learning. Once the two types of uncertainty are both priced in asset prices, their joint effect enables our model to account for the level and volatility of U.S. equity returns without relying on exogenous variation in disaster risk or any realization of disaster shock in the data sample.
Option Prices in a Model With Stochastic Disaster Risk
AbstractContrary to well-known asset pricing models, volatilities implied by equity index options exceed realized stock market volatility and exhibit a pattern known as the volatility skew. We explain both facts using a model that can also account for the mean and volatility of equity returns. Our model assumes a small risk of economic disaster that is calibrated based on international data on large consumption declines. We allow the disaster probability to be stochastic, which turns out to be crucial to the model's ability
both to match equity volatility and to reconcile option prices with macroeconomic data on disasters.
- G0 - General