Faculty of Economics and Business Administration Publications Database

The Dynamics of Crises and the Equity Premium

Selected
Authors:
Branger, Nicole
Source:
Volume: 29
Number: 1
Pages: 232 - 270
Month: January
ISSN-Print: 0893-9454
Link External Source: Online Version
Year: 2016
Abstract:

It is a major challenge for asset pricing models to generate a high equity premium and a low risk-free rate while imposing realistic consumption dynamics. To address this issue, our paper proposes a novel pricing channel: we allow for consumption drops that can spark an economic crisis. This new feature generates a large equity premium even if possible consumption drops are of moderate size. In turn, our model also matches the consumption data of 42 countries along several dimensions. In particular, our approach generates a realistic number of crises that have realistic durations and involve clustering of moderate consumption drops.

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