Rare Disaster Risk and the Expected Equity Risk Premium

22 Pages Posted: 3 Jun 2017

See all articles by Henk Berkman

Henk Berkman

University of Auckland - Business School

Ben Jacobsen

Tilburg University - TIAS School for Business and Society; Massey University

John B. Lee

University of Auckland

Date Written: June 2017

Abstract

Consistent with the predictions of rare disaster models, we find that a proxy for the time‐varying probability of rare disasters helps to explain fluctuations in expectations of the equity risk premium. Our proxy for disaster risk is a recently developed measure of global political instability, and the expected market risk premium is from Value Line analysts' expected stock returns. Consistent with long‐run risk models, uncertainty about expected GDP growth and expected consumption growth is also significantly positively related to the expected market risk premium. We obtain similar results when we use the earnings–price ratio and the dividend–price ratio as proxies for the expected market risk premium.

Keywords: Consumption risk, Equity premium, International political crises, Market risk premium, Rare disasters

Suggested Citation

Berkman, Henk and Jacobsen, Ben and Lee, John B., Rare Disaster Risk and the Expected Equity Risk Premium (June 2017). Accounting & Finance, Vol. 57, Issue 2, pp. 351-372, 2017. Available at SSRN: https://ssrn.com/abstract=2979632 or http://dx.doi.org/10.1111/acfi.12158

Henk Berkman (Contact Author)

University of Auckland - Business School ( email )

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Auckland
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Ben Jacobsen

Tilburg University - TIAS School for Business and Society ( email )

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TIAS Building
Tilburg, Noord Brabant 5037 AB
Netherlands

Massey University ( email )

Auckland
New Zealand

John B. Lee

University of Auckland ( email )

Private Bag 92019
Auckland, 1001
New Zealand
649 373 7599 ext. 85171 (Phone)
649 373 7406 (Fax)

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