Rare Disasters, Asset Prices, and Welfare Costs

Robert Barro

American Economic Review, 2009, vol. 99, issue 1, 243-64

Abstract: A representative-consumer model with Epstein-Zin-Weil preferences and i.i.d. shocks, including rare disasters, accords with observed equity premia and risk-free rates if the coefficient of relative risk aversion equals 3-4. If the intertemporal elasticity of substitution exceeds one, an increase in uncertainty lowers the price-dividend ratio for equity, and a rise in the expected growth rate raises this ratio. Calibrations indicate that society would willingly reduce GDP by around 20 percent each year to eliminate rare disasters. The welfare cost from usual economic fluctuations is much smaller, though still important, corresponding to lowering GDP by about 1.5 percent each year. (JEL E13, E21, E22, E32)

JEL-codes: E13 E21 E22 E32 (search for similar items in EconPapers)
Date: 2009
Note: DOI: 10.1257/aer.99.1.243
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Citations: View citations in EconPapers (535)

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Working Paper: Rare Disasters, Asset Prices, and Welfare Costs (2007)
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