Rare Disasters, Tail Aversion, and Asset Pricing Puzzles

Gerrit Meyerheim

No 12231, CESifo Working Paper Series from CESifo

Abstract: This paper integrates tail aversion, implemented via a one-period entropic tilt, with rare disasters in a consumption-based asset pricing model with CRRA utility to jointly address the equity premium and risk-free rate puzzles. The model delivers closed-form expressions for the risk-free rate and asset moments, pushes out the Hansen-Jagannathan bound, implies a low risk-free rate via diffusion and disaster channels, and delivers natural upper and lower bounds of risk aversion. Calibrated to long-run return data and disciplined by disaster evidence, the model matches average returns, volatility, and a low real risk-free rate with very modest risk aversion.

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
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Persistent link: https://EconPapers.repec.org/RePEc:ces:ceswps:_12231

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