The Taming of the Two - Simulation-Based Asset Pricing with Multi-Period Disasters and Two Consumption Goods
70 Pages Posted: 23 Mar 2017 Last revised: 4 Oct 2018
Date Written: September 26, 2018
This study proposes a novel approach to facilitate the estimation of the preference parameters of a two consumption good C-CAPM that accounts for multi-period disasters, partial government defaults, and the possible destruction of the stock of the durable good. The maximum likelihood estimation of the disaster process parameters requires a cross-country panel of historical consumption data and international business cycle dates. The estimation of the risk aversion coefficient and the intertemporal elasticity of substitution (IES) is facilitated by the simulated method of moments. The results show that the empirical equity premium can be explained with economically plausible and quite precise risk aversion and IES estimates. This conclusion withstands a battery of robustness checks.
Keywords: multi-period disasters, durable good, simulated method of moments, government defaults
JEL Classification: C58, G12
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