Can Time-Varying Risk of Rare Disasters Explain Aggregate Stock Market Volatility?

Jessica Wachter ()

No 14386, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Why is the equity premium so high, and why are stocks so volatile? Why are stock returns in excess of government bill rates predictable? This paper proposes an answer to these questions based on a time-varying probability of a consumption disaster. In the model, aggregate consumption follows a normal distribution with low volatility most of the time, but with some probability of a consumption realization far out in the left tail. The possibility of this poor outcome substantially increases the equity premium, while time-variation in the probability of this outcome drives high stock market volatility and excess return predictability.

JEL-codes: G12 (search for similar items in EconPapers)
Date: 2008-10
New Economics Papers: this item is included in nep-dge, nep-fmk, nep-rmg and nep-upt
Note: AP EFG
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (32)

Published as Jessica A. Wachter, 2013. "Can Time-Varying Risk of Rare Disasters Explain Aggregate Stock Market Volatility?," Journal of Finance, American Finance Association, vol. 68(3), pages 987-1035, 06.

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Related works:
Journal Article: Can Time-Varying Risk of Rare Disasters Explain Aggregate Stock Market Volatility? (2013)
Working Paper: Can time-varying risk of rare disasters explain aggregate stock market volatility? (2008)
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