 Overextrapolation of disaster probabilities and asset pricing in a production economyHan Gao, Chunpeng Lin, Juan Peng and Siqi Zhao International Review of Economics & Finance, 2024, vol. 89, issue PA, 845-854 Abstract: In this paper, the overextrapolation belief about the jump intensity of disaster risk is incorporated into an equilibrium asset pricing model in a production economy. The theoretical results, which are dependent on the level of the jump intensity, show that overextrapolation may induce over/underinvestment and under/overconsumption. Moreover, it is predicted that the overextrapolative agent will always overreact on investment and consumption, which results in higher volatility in the economy and generates a higher equity risk premium under the equilibrium model. However, the effects of overextrapolation on the interest rate are ambiguous. Finally, we find that the overextrapolative agent suffers significant welfare loss due to the distortion of investment and consumption, especially when the jump intensity is far from the long-run mean. Keywords: Overextrapolation; Disaster probabilities; Investment; Asset pricing; Welfare loss (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:reveco:v:89:y:2024:i:pa:p:845-854 DOI: 10.1016/j.iref.2023.07.078 Access Statistics for this article International Review of Economics & Finance is currently edited by H. Beladi and C. Chen More articles in International Review of Economics & Finance from Elsevier |
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