Asset pricing with long-run disaster risk

Rujie Fan and Chao Xiao

PLOS ONE, 2023, vol. 18, issue 6, 1-21

Abstract: Traditional disaster models with time-varying disaster risk are not perfect in explaining asset returns. We redefine rare economic disasters and develop a novel disaster model with long-run disaster risk to match the asset return moments observed in the U.S. data. The difference from traditional disaster models is that our model contains the long-run disaster risk by treating the long-run ingredient of consumption growth as a function of time-varying disaster probability. Our model matches the U.S. data better than the traditional disaster model with time-varying disaster risk. This study uncovers an additional channel through which disaster risk affects asset returns and bridges the gap between long-run risk models and rare disaster models.

Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:plo:pone00:0287687

DOI: 10.1371/journal.pone.0287687

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