The Time-Varying Risk of Macroeconomic Disasters

Roberto Marfe () and Julien Penasse

No 463, Carlo Alberto Notebooks from Collegio Carlo Alberto

Abstract: While time-varying disasters can explain many characteristics of financial markets, their quantitative assessment is still missing. We propose a latent variable approach to estimate the time-varying probability of a macroeconomic disaster, using a dataset of 42 countries over more than 100 years. We find that disaster risk is volatile and persistent, strongly correlates with the dividend yield, and forecasts stock returns. A state-of-the-art model calibrated with our disaster risk estimates generates a large and volatile equity premium and a low risk free rate under standard assumptions. This evidence supports the idea that investors' fear of disasters drives equity premium dynamics.

Keywords: rare disasters; equity premium; return predictability; state-space model (search for similar items in EconPapers)
JEL-codes: E44 G12 G17 (search for similar items in EconPapers)
Pages: pages 46
Date: 2016
New Economics Papers: this item is included in nep-dcm, nep-mac, nep-rmg and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:cca:wpaper:463

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