Disasterization: A Simple Way to Fix the Asset Pricing Properties of Macroeconomic Models

Xavier Gabaix

American Economic Review, 2011, vol. 101, issue 3, 406-09

Abstract: 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.

Date: 2011
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