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Rare disasters, asset prices, and welfare costs / Robert J. Barro

Author
Barro, Robert J.
Published
Cambridge, Mass. : National Bureau of Economic Research, [2007]
Copyright Date
©2007
Physical Description
42 pages : illustrations ; 22 cm.
Additional Creators
National Bureau of Economic Research
Online Version

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Summary
A representative-consumer model with Epstein-Zin-Weil preferences and i.i.d. shocks, including rare disasters, accords with key asset-pricing observations. If the coefficient of relative risk aversion equals 3-4, the model accords with observed equity premia and risk-free real interest rates. If the intertemporal elasticity of substitution is greater than one, an increase in uncertainty lowers the price-dividend ratio for equity, whereas a rise in the expected growth rate raises this ratio. In a model with endogenous saving, more uncertainty lowers the saving ratio (because substitution effects dominate). The match with major features of asset pricing suggests that the model is a reasonable candidate for assessing the welfare cost of aggregate consumption uncertainty. In the baseline simulation, the welfare cost of disaster risk is large -- society would be willing to lower real GDP by as much as 20% each year to eliminate the small chance of major economic collapses. The welfare cost from usual economic fluctuations is much smaller, though still important, corresponding to lowering GDP by around 1.5% each year.
Subject(s)
Note
"December 2007."
Bibliography Note
Includes bibliographical references (pages 36-39).
Other Forms
Also available in PDF from the NBER world wide web site (www.nber.org).
View MARC record | catkey: 4310530