Consumption-Based Asset Pricing with Rare Disaster Risk - A Simulated Method of Moments Approach

52 Pages Posted: 18 Feb 2014 Last revised: 4 Oct 2018

See all articles by Joachim Grammig

Joachim Grammig

University of Tübingen

Jantje Sönksen

University of Tübingen

Date Written: September 26, 2018

Abstract

We propose a simulated method of moments strategy to estimate a consumption-based asset pricing model (CBM) that accounts for the possibility of severe economic contractions, thereby providing a test of the rare disaster hypothesis and a re-evaluation of the empirical performance of the canonical CBM. Unlike in previous studies, the estimates of the investor preference parameters and the model-implied equity premium, mean risk-free rate, and market Sharpe ratio are economically plausible and precise. Accounting for rare disasters thus helps to restore the nexus between financial markets and the real economy that is implied by the CBM.

Keywords: rare disaster hypothesis, simulated method of moments, consumption-based asset pricing

JEL Classification: C58, G12

Suggested Citation

Grammig, Joachim and Sönksen, Jantje, Consumption-Based Asset Pricing with Rare Disaster Risk - A Simulated Method of Moments Approach (September 26, 2018). Available at SSRN: https://ssrn.com/abstract=2397065 or http://dx.doi.org/10.2139/ssrn.2397065

Joachim Grammig (Contact Author)

University of Tübingen ( email )

Mohlstrasse 36
72074 Tübingen, Baden Wuerttemberg 72074
Germany

Jantje Sönksen

University of Tübingen ( email )

Sigwartstr. 18
Tübingen, Baden-Wuerttemberg 72076
Germany

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