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Risk of Rare Disasters, Euler Equation Errors and the Performance of the C-CAPM

Olaf Posch () and Andreas Schrimpf

VfS Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order from Verein für Socialpolitik / German Economic Association

Abstract: This paper shows that the consumption-based asset pricing model (C-CAPM) with low-probability disaster risk rationalizes large pricing errors, i.e., Euler equation errors. This result is remarkable, since Lettau and Ludvigson (2009) show that leading asset pricing models cannot explain sizeable pricing errors in the C-CAPM. We also show (analytically and in a Monte Carlo study) that implausible estimates of risk aversion and time preference are not puzzling in this framework and emerge as a result of rational pricing errors. While this bias essentially removes the pricing error in the traditional endowment economy, a production economy with stochastically changing investment opportunities generates large and persistent empirical pricing errors.

JEL-codes: E21 G12 O41 (search for similar items in EconPapers)
Date: 2013
New Economics Papers: this item is included in nep-mac
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Working Paper: Risk of Rare Disasters, Euler Equation Errors and the Performance of the C-CAPM (2012) Downloads
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