Asset Pricing with Endogenous Disasters

56 Pages Posted: 19 Mar 2008 Last revised: 31 Dec 2009

See all articles by Cristian Ioan Tiu

Cristian Ioan Tiu

University at Buffalo; TIAA Institute

Uzi Yoeli

University of Texas at Austin - Department of Finance

Date Written: December 28, 2009

Abstract

We propose a model with endogenous disasters generated through a labor dynamics mechanism. The model is parsimonious, having only one continuous state variable as well as CRRA agents with reasonable risk aversion. In such a simple setting we solve for prices in closed form and show that we can account for the high equity premium and volatility observed in the U.S. stock market as well as for a low riskfree rate. Excess returns and volatility are predictable and dividend yields implied by our model constitute stronger predictors than the observed dividend yield or cay. Having generated disasters through a labor mechanism, we are able to validate our model by calibrating it to labor-specific data, such as labor's share of income, while testing its asset pricing predictions, such as the magnitude of the consumption drop in an economic collapse.

Keywords: Disaster, Peso effect, Asset Pricing, Productivity

JEL Classification: G12

Suggested Citation

Tiu, Cristian Ioan and Yoeli, Uzi, Asset Pricing with Endogenous Disasters (December 28, 2009). AFA 2009 San Francisco Meetings Paper, Available at SSRN: https://ssrn.com/abstract=1108565 or http://dx.doi.org/10.2139/ssrn.1108565

Cristian Ioan Tiu (Contact Author)

University at Buffalo ( email )

238 Jacobs Management Center
Jacobs Hall, North Campus
Buffalo, NY NY 14260
United States
7166453299 (Phone)

TIAA Institute ( email )

8500 Andrew Carnegie Blvd
E3/S8
Charlotte, NC 28262
United States

Uzi Yoeli

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States
512-471-1676 (Phone)

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