Endogenous Disasters and Asset Prices

Charles A. Dice Center Working Paper No. 2012-1

Fisher College of Business Working Paper No. 2012-03-001

60 Pages Posted: 4 Jan 2012 Last revised: 13 May 2014

Nicolas Petrosky-Nadeau

Federal Reserve Banks - Federal Reserve Bank of San Francisco

Lu Zhang

Ohio State University - Fisher College of Business; National Bureau of Economic Research (NBER)

Lars-Alexander Kuehn

Carnegie Mellon University - David A. Tepper School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: October 1, 2013

Abstract

Frictions in the labor market are important for understanding the equity premium in the financial market. We embed the Diamond-Mortensen-Pissarides search framework into a dynamic stochastic general equilibrium model with recursive preferences. The model produces realistic equity premium and stock market volatility, as well as a low and stable interest rate. The equity premium is countercyclical, and forecastable with labor market tightness, a pattern we confirm in the data. Intriguingly, three key ingredients (small profits, large job flows, and matching frictions) in the model combine to give rise endogenously to rare disasters a la Rietz (1988) and Barro (2006).

Keywords: Search frictions, equity premium puzzle, rare disasters, time-varying risk premiums, dynamic stochastic general equilibrium, unemployment, labor market tightness

JEL Classification: E21, E24, E40, G12

Suggested Citation

Petrosky-Nadeau, Nicolas and Zhang, Lu and Kuehn, Lars-Alexander, Endogenous Disasters and Asset Prices (October 1, 2013). Charles A. Dice Center Working Paper No. 2012-1; Fisher College of Business Working Paper No. 2012-03-001. Available at SSRN: https://ssrn.com/abstract=1979625 or http://dx.doi.org/10.2139/ssrn.1979625

Nicolas Petrosky-Nadeau

Federal Reserve Banks - Federal Reserve Bank of San Francisco ( email )

101 Market Street
San Francisco, CA 94105
United States

Lu Zhang (Contact Author)

Ohio State University - Fisher College of Business ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States
585-267-6250 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Lars-Alexander Kuehn

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States

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