Rare Disasters, Tail Aversion, and Asset Pricing Puzzles

Gerrit Meyerheim

No 12231, CESifo Working Paper Series from CESifo

Abstract: This paper develops a parsimonious consumption-based asset pricing model that integrates tail aversion, implemented via a one-period entropic tilt, with rare disasters under CRRA utility. Closed-form expressions for the risk-free rate, return moments, and the Hansen-Jagannathan bound yield an analytic mapping from moments to structural parameters and bounds on risk aversion. Calibrated to long-run return data and disciplined by disaster evidence, the model reconciles the equity premium and risk-free rate puzzles with very modest risk aversion. The same calibration generates an option-implied variance risk premium, realistic crash insurance prices, and a two-component Black-Scholes mixture with a moderate downward-sloping implied volatility skew.

Keywords: equity premium puzzle; risk-free rate puzzle; rare disasters; entropic tilt; multiplier (KL) preferences; robust control; consumption-based asset pricing (search for similar items in EconPapers)
JEL-codes: D81 E21 E43 E44 G12 (search for similar items in EconPapers)
Date: 2025
New Economics Papers: this item is included in nep-env, nep-rmg and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:ces:ceswps:_12231

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