Rare Disasters and Asset Markets in the Twentieth Century

By Robert J. Barro. 2006

2,086 citations recorded by the source corpus.

The potential for rare economic disasters explains a lot of asset-pricing puzzles. I calibrate disaster probabilities from the twentieth century global history, especially the sharp contractions associated with World War I, the Great Depression, and World War II. The puzzles that can be explained include the high equity premium, low risk-free rate, and volatile stock returns. Another mystery that may be resolved is why expected real interest rates were low in the United States during major wars, such as World War II. The model, an extension of work by Rietz, maintains the tractable framework of a representative agent, time-additive and isoelastic preferences, and complete markets. The results hold with i.i.d. shocks to productivity growth in a Lucas-tree type economy and also with the inclusion of capital formation.

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/e31d7435874b69347cbbf60546108433d2523e66

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Citations in the corpus

Portfolio selection with higher moments (2010, neutral): “…Brunnermeier and Parker (2005), Jurczenko et al. (2005), Liew and French (2005), Sfiridis (2005), Ang et al. (2006), Bakshi and Madan (2006), Barro (2006), Williams and Ioannidis (2006), Barberis and Huang (2007), Briec et al. (2007), Brunnermeier et al. (2007), Chiang and Li (2007),…”
Exploitable Predictable Irrationality: The FIFA World Cup Effect on the U.S. Stock Market (2010, background): “The events are taken from Barro (2006), Haugen, Talmor, and Torous (1991), and Wikipedia (http://en.wikipedia.org/), which covers almost 2.5 million articles.”
Debt Sustainability under Catastrophic Risk: The Case for Government Budget Insurance (2007, neutral): “García, Marcio, and Roberto Rigobón, 2004, “A Risk Management Approach to Emerging Market’s Sovereign Debt Sustainability with an Application to Brazilian Data,” NBER Working Paper No. 10336 (Cambridge, Massachusetts: National Bureau of Economic Research).”
Exporting under trade policy uncertainty: Theory and evidence (2014, background): “7 Even if feared reversals to disastrous trade protection or threatened trade wars never materialize, the small possibility of these worst case scenario outcomes can have measurable economic effects, as Barro (2006) has recently shown for asset markets.”
Rare Disasters and Risk Sharing with Heterogeneous Beliefs (2011, methodology): “When we calibrate the beliefs of one agent using international macroeconomic data (from Barro 2006) and the other using consumption data from the United States (where disasters have been relatively mild), raising the fraction of total wealth for the second agent from 0% to 10% lowers the equity…”
Estimating Nonlinear DSGE Models by the Simulated Method of Moments (2010, positive): “[16] On the other hand, quantitative results by Rietz (1988) and Barro (2006, 2009) suggest that extreme, low probability events|presumably arising from an asymmetric distribution| may have large economic implications in a setup where agents are risk averse.”
Advances in Consumption-Based Asset Pricing: Empirical Tests (2011, positive): “They find smaller probabilities of extreme outcomes than what is estimated from the Barro international data. Julliard and Ghosh (2010) estimate the consumption Euler equations of the standard model allowing explicitly for the probabilities attached to different states to differ from their sample fr”
Displacement Risk and Asset Returns (2012, background): “As Barro (2006) argues, in the absence of financial leverage the model-implied equity premium should be about two thirds of the equity premium observed in the data (since in reality equity is levered).”
Commodity Trade and the Carry Trade: a Tale of Two Countries (2017, background): “…magnitudes of currency risk premia and interest rates we calibrate it by allowing for the possibility of very large jumps in productivity - i.e., rare disasters, as in the literature on the equity premium puzzle (e.g., Longstaff and Piazzesi (2004), Barro (2006), Gabaix (2012), Wachter (2013)).”
Trade and Investment under Policy Uncertainty: Theory and Firm Evidence (2015, background): “events are irrelevant for investment decisions, as recently emphasized in a di¤erent context by Barro (2006). Even if the fears of temporary reversal to protection or major trade wars never materialize, the”
Too-Systemic-To-Fail: What Option Markets Imply About Sector-Wide Government Guarantees (2016, positive): “To model the asset pricing impact of financial disasters, we use a version of the Barro (2006), Rietz (1988) and Longstaff and Piazzesi (2004) asset pricing models with a time-varying probability of disasters, as developed by Gabaix (2008), Wachter (2008) and Gourio (2008).”
Catastrophic Natural Disasters and Economic Growth (2010, neutral): “The system of equations in (5), (6) and (7) can hold exactly only if (Y1;1; ::::::::; Y1;T0 ;Z 0 1) belongs to the convex hull of”
Home bias in open economy financial macroeconomics (2013, neutral): “S H,t + S F H,t = S F F,t + S H F,t = 1 (12)”
Earnings and Consumption Dynamics: A Nonlinear Panel Data Framework (2015, methodology): “For estimation we use a series quantile specification, as in (5), based on a third-order Hermite polynomial.”
Macroeconomics and Household Heterogeneity (2016, background): “(6) 26 This chapter shares the focus on rare but large economic crises with the body of work on rare disasters, see e.g. Rietz (1988), Barro (2006) and Gourio (2013).”