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The Dynamics of Crises and the Equity Premium

SAFE Working Paper No. 11

48 Pages Posted: 2 Jul 2010 Last revised: 20 May 2015

Nicole Branger

University of Muenster - Finance Center Muenster

Holger Kraft

Goethe University Frankfurt

Christoph Meinerding

Deutsche Bundesbank

Date Written: May 18, 2015

Abstract

It is a major challenge for asset pricing models to generate a high equity premium and a low risk-free rate while imposing realistic consumption dynamics. To address this issue, our paper proposes a novel pricing channel: We allow for consumption drops that can spark an economic crisis. This new feature generates a large equity premium even if possible consumption drops are of moderate size. In turn, our model also matches the consumption data of 42 countries along several dimensions. In particular, our approach generates a realistic number of crises that have realistic durations and involve clustering of moderate consumption drops.

Keywords: General Equilibrium, Asset Pricing, Recursive Preferences, Long-Run Risk, Disaster Models

JEL Classification: G01, G12

Suggested Citation

Branger, Nicole and Kraft, Holger and Meinerding, Christoph, The Dynamics of Crises and the Equity Premium (May 18, 2015). SAFE Working Paper No. 11. Available at SSRN: https://ssrn.com/abstract=1633480 or http://dx.doi.org/10.2139/ssrn.1633480

Nicole Branger

University of Muenster - Finance Center Muenster ( email )

Universitatsstr. 14-16
Muenster, 48143
Germany
+49 251 83 29779 (Phone)
+49 251 83 22867 (Fax)

HOME PAGE: http://www.wiwi.uni-muenster.de/fcm/fcm/das-finance-center/details.php?weobjectID=162

Holger Kraft

Goethe University Frankfurt ( email )

Faculty of Economics and Business Administration
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Christoph Meinerding (Contact Author)

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

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