Can COVID-19 Solve The Equity Premium Puzzle?
25 Pages Posted: 9 Feb 2021 Last revised: 11 Mar 2021
Date Written: February 7, 2021
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: Suggested Citation