Real(istic) Time-Varying Probability of Consumption Disasters

64 Pages Posted: 30 Apr 2021 Last revised: 18 May 2021

See all articles by Xiaoyu Huang

Xiaoyu Huang

Tsinghua University - PBC School of Finance

Tao Jin

Tsinghua University - PBC School of Finance

Hao Zhou

SUSTech Business School; Tsinghua University - PBC School of Finance

Date Written: March 31, 2021

Abstract

We model the time-varying probability of consumption disasters with international risk interactions and estimate the model using national accounts data of 42 countries back to 1833. The estimated world and country-specific disaster probabilities accord well with historical macroeconomic disasters. A match of equity premium requires a relative risk aversion coefficient around 5, substantively smaller than the previous estimates. Also, the model delivers a significantly better match for the equity volatility than alternative rare disaster models. Finally, the disaster probability index estimated from the model can predict equity returns in the very long term---up to 50 years.

Keywords: consumption disasters, time-varying probability, asset pricing, risk aversion, equity-premium prediction

JEL Classification: G12, E21, E44

Suggested Citation

Huang, Xiaoyu and Jin, Tao and Zhou, Hao, Real(istic) Time-Varying Probability of Consumption Disasters (March 31, 2021). Available at SSRN: https://ssrn.com/abstract=2944788 or http://dx.doi.org/10.2139/ssrn.2944788

Xiaoyu Huang

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengdu Road
Haidian District
Beijing 100083
China

Tao Jin (Contact Author)

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengdu Road
Haidian District
Beijing 100083
China

Hao Zhou

SUSTech Business School ( email )

1088 Xueyuan Avenue, Nanshan District
Southern University of Science and Technology
Shenzhen, Guangdong
China
+86-0755-88010464 (Phone)

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengfu Road
Haidian District
Beijing, 100083
China
+86-10-62790655 (Phone)

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