Department of Economics and Business Economics

Olaf Posch

Risk of Rare Disasters, Euler Equation Errors and the Performance of the C-CAPM

Research output: Working paperResearch

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  • Rp12 32

    Submitted manuscript, 694 KB, PDF document

This paper shows that the consumption-based asset pricing model (C-CAPM) with low-probability disaster risk rationalizes large pricing errors, i.e. Euler equation errors. This result is remarkable, since Lettau and Ludvigson (2009) show that leading asset pricing models cannot explain sizeable pricing errors in the C-CAPM. We also show (analytically and in a Monte Carlo study) that implausible estimates of risk aversion and time preference are not puzzling in this framework and emerge as a result of rational pricing errors. While this bias essentially removes the pricing error in the traditional endowment economy, a production economy with stochastically changing investment opportunities generates large and persistent empirical pricing errors.
Original languageEnglish
Place of publicationAarhus
PublisherInstitut for Økonomi, Aarhus Universitet
Number of pages45
Publication statusPublished - 10 Jul 2012
SeriesCREATES Research Papers
Number2012-32

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