Can COVID-19 solve the equity premium puzzle?

Messaoud Chibane

Applied Economics, 2023, vol. 55, issue 6, 603-616

Abstract: We propose a new approach for estimating rare disaster event models where we only use U.S. national consumption data as an alternative to the ubiquitous Barro and Ursúa’s (2008, 2012) multi-country data set. We find that the 2020 COVID crisis unambiguously reveals the presence and significance of rare disasters in consumption dynamics. Using our estimated parameters and recursive preferences, our approach is able to solve the risk-free rate and equity premium puzzles without resorting to multi-country data in estimating the model. Our analysis shows that the severity of disasters is vastly underestimated in the U.S. and that more than 400 years of consumption data would be necessary to get an accurate estimate.

Date: 2023
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DOI: 10.1080/00036846.2022.2092053

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