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

CFS Working Paper No. 480

60 Pages Posted: 11 Oct 2014 Last revised: 29 Jun 2016

See all articles by Joachim Grammig

Joachim Grammig

Eberhard Karls Universitaet Tübingen; Centre for Financial Research (CfR); Center for Financial Studies (CfS)

Jantje Soenksen

University of Tuebingen

Date Written: June 28, 2016

Abstract

We 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, we find that the estimates of the investor preference parameters and the model-implied equity premium, mean risk-free rate, and market Sharpe ratio are perfectly 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 consumption-based asset pricing approach.

Keywords: equity premium, rare disaster risk, asset pricing, simulated method of moments

JEL Classification: G10, G12, C58

Suggested Citation

Grammig, Joachim and Soenksen, Jantje, Consumption-Based Asset Pricing with Rare Disaster Risk - A Simulated Method of Moments Approach (June 28, 2016). CFS Working Paper No. 480. Available at SSRN: https://ssrn.com/abstract=2508150 or http://dx.doi.org/10.2139/ssrn.2508150

Joachim Grammig (Contact Author)

Eberhard Karls Universitaet Tübingen ( email )

Mohlstrasse 36
D-72074 Tuebingen, 72074
Germany

HOME PAGE: http://www.uni-tuebingen.de/uni/wwo/Grammig/grammigeng.html

Centre for Financial Research (CfR) ( email )

Albertus-Magnus Platz
Cologne, 50923
Germany

Center for Financial Studies (CfS) ( email )

Taunusanlage 6
Frankfurt/Germany, D-60329
Germany

Jantje Soenksen

University of Tuebingen ( email )

Mohlstrasse 36
Tuebingen, Baden-Wuerttemberg 72074
Germany

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