On the effects of pessimism toward pollution-driven disasters on equity premiums

Shiba Suzuki () and Hiroaki Yamagami ()
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Shiba Suzuki: Seikei University
Hiroaki Yamagami: Seikei University

Economic Theory Bulletin, 2024, vol. 12, issue 2, No 4, 167-181

Abstract: Abstract This study explores how investors’ subjective perception of pollution-driven disasters affects asset prices. Environmental pollution resulting from economic activities raises the probability of disasters. However, the relationship between economic activity and pollution-driven disasters is difficult to ascertain. Thus, investors make decisions based on subjective expectations; they subjectively evaluate the probability of disasters pessimistically. We investigate whether a pessimistic perception toward pollution-driven disasters causes high equity premiums by deriving a closed-form solution for the equity premium under a Markov process. Our contribution is to demonstrate that pessimism magnifies the equity premium even when the intertemporal elasticity of substitution is slightly lower than 1, which is empirically plausible.

Keywords: Subjective expectations; Disasters; Intertemporal elasticity of substitution; Equity premium; E71; G12; Q54 (search for similar items in EconPapers)
Date: 2024
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DOI: 10.1007/s40505-024-00270-0

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