Can Time-Varying Risk of Rare Disasters Explain Aggregate Stock Market Volatility? / Jessica Wachter.

By:

Wachter, Jessica

Contributor(s):

National Bureau of Economic Research

Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w14386.Publication details: Cambridge, Mass. National Bureau of Economic Research 2008.Description: 1 online resource: illustrations (black and white)Subject(s):

G12 - Asset Pricing • Trading Volume • Bond Interest Rates

Online resources:

Available additional physical forms:

Hardcopy version available to institutional subscribers

Abstract: Why is the equity premium so high, and why are stocks so volatile? Why are stock returns in excess of government bill rates predictable? This paper proposes an answer to these questions based on a time-varying probability of a consumption disaster. In the model, aggregate consumption follows a normal distribution with low volatility most of the time, but with some probability of a consumption realization far out in the left tail. The possibility of this poor outcome substantially increases the equity premium, while time-variation in the probability of this outcome drives high stock market volatility and excess return predictability.

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Item type	Home library	Collection	Call number	Status	Date due	Barcode	Item holds
Working Paper	Biblioteca Digital	Colección NBER	nber w14386 (Browse shelf(Opens below))	Not For Loan

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October 2008.

Why is the equity premium so high, and why are stocks so volatile? Why are stock returns in excess of government bill rates predictable? This paper proposes an answer to these questions based on a time-varying probability of a consumption disaster. In the model, aggregate consumption follows a normal distribution with low volatility most of the time, but with some probability of a consumption realization far out in the left tail. The possibility of this poor outcome substantially increases the equity premium, while time-variation in the probability of this outcome drives high stock market volatility and excess return predictability.