Can COVID-19 Solve The Equity Premium Puzzle?

25 Pages Posted: 9 Feb 2021 Last revised: 11 Mar 2021

Date Written: February 7, 2021

Abstract

We propose a new approach for estimating rare disaster event models where we only use U.S. national consumption data as an alternative to the ubiquitous Barro and Urs´ua’s (2008, 2012) multi-country data set. We find that the 2020 COVID crisis unambiguously reveals the presence and significance of rare disasters in consumption dynamics. Using our estimated parameters and recursive preferences, our approach is able to solve the risk-free rate and equity premium puzzles without resorting to multi-country data in estimating the model. Our analysis shows that the severity of disasters is vastly underestimated in the U.S. and that more than 200 years of consumption data would be necessary to get an accurate estimate.

Keywords: Rare Disaster Events, COVID 19, Equity Premium, Risk-Free Rate

JEL Classification: G01, G14

Suggested Citation

Chibane, Messaoud, Can COVID-19 Solve The Equity Premium Puzzle? (February 7, 2021). Available at SSRN: https://ssrn.com/abstract=3781020 or http://dx.doi.org/10.2139/ssrn.3781020

Messaoud Chibane (Contact Author)

Neoma Business School ( email )

1 Rue du Maréchal Juin
Mont Saint Aignan Cedex, 76825
France

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