Finance Papers

Document Type

Journal Article

Date of this Version

12-2015

Publication Source

Annual Review of Financial Economics

Volume

7

Start Page

219

Last Page

252

DOI

10.1146/annurev-financial-111914-041906

Abstract

After lying dormant for more than two decades, the rare disaster framework has emerged as a leading contender to explain facts about the aggregate market, interest rates, and financial derivatives. In this article, we survey recent models of disaster risk that provide explanations for the equity premium puzzle, the volatility puzzle, return predictability, and other features of the aggregate stock market. We show how these models can also explain violations of the expectations hypothesis in bond pricing as well as the implied volatility skew in option pricing. We review both modeling techniques and results and consider both endowment and production economies. We show that these models provide a parsimonious and unifying framework for understanding puzzles in asset pricing.

Copyright/Permission Statement

Posted with permission from the Annual Review of Financial Economics, Volume 7© by Annual Reviews, http://www.annualreviews.org.

Keywords

rare events, fat tails, equity premium puzzle, volatility puzzle

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Date Posted: 27 November 2017

This document has been peer reviewed.