Learning, Rare Disasters, and Asset Prices

Posted: 9 Jul 2021

See all articles by Yang Lu

Yang Lu

affiliation not provided to SSRN

Michael Siemer

affiliation not provided to SSRN

Date Written: November, 2013

Abstract

In this paper, we examine how learning about disaster risk affects asset pricing in an endowment economy. We extend the literature on rare disasters by allowing for two sources of uncertainty: (1) the lack of historical data results in unknown parameters for the disaster process, and (2) the disaster takes time to unfold and is not directly observable. The model generates time variation in the risk premium through Bayesian updating of agents' beliefs regarding the likelihood and severity of disaster realization. The model accounts for the level and volatility of U.S. equity returns and generates predictability in returns.

JEL Classification: D83, E21, G12

Suggested Citation

Lu, Yang and Siemer, Michael, Learning, Rare Disasters, and Asset Prices (November, 2013). FEDS Working Paper No. 2013-85, Available at SSRN: https://ssrn.com/abstract=3879380

Yang Lu (Contact Author)

affiliation not provided to SSRN

No Address Available

Michael Siemer

affiliation not provided to SSRN

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