Disaster Risk and Asset Returns: An International Perspective

78 Pages Posted: 2 Mar 2017

See all articles by Karen K. Lewis

Karen K. Lewis

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)

Edith X. Liu

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: 2017-02

Abstract

Recent studies have shown that disaster risk can generate asset return moments similar to those observed in the U.S. data. However, these studies have ignored the cross-country asset pricing implications of the disaster risk model. This paper shows that standard U.S.-based disaster risk model assumptions found in the literature lead to counterfactual international asset pricing implications. Given consumption pricing moments, disaster risk cannot explain the range of equity premia and government bill rates nor the high degree of equity return correlation found in the data. Moreover, the independence of disasters presumed in some studies generates counterfactually low cross-country correlations in equity markets. Alternatively, if disasters are all shared, the model generates correlations that are excessively high. We show that common and idiosyncratic components of disaster risk are needed to explain the pattern in consumption and equity co-movements.

Keywords: Rare disaster, Asset returns, International correlations

JEL Classification: F3, F4, G1

Suggested Citation

Lewis, Karen Kay and Liu, Edith X., Disaster Risk and Asset Returns: An International Perspective (2017-02). FRB International Finance Discussion Paper No. 1199, Available at SSRN: https://ssrn.com/abstract=2925706 or http://dx.doi.org/10.17016/IFDP.2017.1199

Karen Kay Lewis (Contact Author)

University of Pennsylvania - Finance Department ( email )

The Wharton School
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National Bureau of Economic Research (NBER)

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Edith X. Liu

Board of Governors of the Federal Reserve System ( email )

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Washington, DC 20551
United States
202-452-3913 (Phone)

HOME PAGE: http://https://www.federalreserve.gov/econresdata/edith-x-liu.htm

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