Rare Disasters and Risk Sharing with Heterogeneous Beliefs

Hui Chen (), Scott Joslin and Ngoc-Khanh Tran

No 16035, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Although the threat of rare economic disasters can have large effect on asset prices, difficulty in inference regarding both their likelihood and severity provides the potential for disagreements among investors. Such disagreements lead investors to insure each other against the types of disasters each one fears the most. Due to the highly nonlinear relationship between consumption losses in a disaster and the risk premium, a small amount of risk sharing can significantly attenuate the effect that disaster risk has on the equity premium. We characterize the sensitivity of risk premium to wealth distribution analytically. Our model shows that time variation in the wealth distribution and the amount of disagreement across agents can both lead to significant variation in disaster risk premium. It also highlights the conditions under which disaster risk premium will be large, namely when disagreement across agents is small or when the wealth distribution is highly concentrated in agents fearful of disasters. Finally, the model predicts an inverse U-shaped relationship between the equity premium and the size of the disaster insurance market.

JEL-codes: G12 (search for similar items in EconPapers)
Date: 2010-05
Note: AP
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

Published as Hui Chen & Scott Joslin & Ngoc-Khanh Tran, 2012. "Rare Disasters and Risk Sharing with Heterogeneous Beliefs," Review of Financial Studies, Society for Financial Studies, vol. 25(7), pages 2189-2224.

Downloads: (external link)
http://www.nber.org/papers/w16035.pdf (application/pdf)

Related works:
Journal Article: Rare Disasters and Risk Sharing with Heterogeneous Beliefs (2012)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:nbr:nberwo:16035

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w16035

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().