Heterogeneous Beliefs, Rare Disasters, and Asset Pricing
We illustrate the effects of heterogeneous beliefs about disasters on the equity premium and individual agents’ trading activities. When investors disagree about the chances or severity of disasters, those optimistic investors may insure the pessimists against their disaster risk exposure. Due to...
| Main Authors: | , , |
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| Other Authors: | |
| Format: | Article |
| Language: | en_US |
| Published: |
American Economic Association
2011
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| Online Access: | http://hdl.handle.net/1721.1/67455 https://orcid.org/0000-0001-9605-641X |
| _version_ | 1826191139693133824 |
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| author | Chen, Hui Joslin, Scott Stephen Walter Tran, Ngoc-Khanh |
| author2 | Sloan School of Management |
| author_facet | Sloan School of Management Chen, Hui Joslin, Scott Stephen Walter Tran, Ngoc-Khanh |
| author_sort | Chen, Hui |
| collection | MIT |
| description | We illustrate the effects of heterogeneous beliefs about disasters on the equity premium
and individual agents’ trading activities. When investors disagree about the chances or
severity of disasters, those optimistic investors may insure the pessimists against their
disaster risk exposure. Due to the highly non-linear relationship between the consumption
losses during a disaster and the risk premium, a small amount of risk sharing can
significantly attenuate the effect that disasters have on the equity premium. Thus, the
equity premium will remain low even when the economy is predominantly occupied by
pessimistic investors, but jump up following a disaster. The effects of risk sharing become
stronger when the differences in beliefs are large, or when the optimistic agents
also have lower risk aversion. Other interesting predictions of the model include a nonmonotonic relationship between the equity premium and the size of the disaster insurance
market, as well as a negative relationship between the equity premium and the amount
of disagreements about disasters. |
| first_indexed | 2024-09-23T08:50:49Z |
| format | Article |
| id | mit-1721.1/67455 |
| institution | Massachusetts Institute of Technology |
| language | en_US |
| last_indexed | 2024-09-23T08:50:49Z |
| publishDate | 2011 |
| publisher | American Economic Association |
| record_format | dspace |
| spelling | mit-1721.1/674552022-09-23T14:57:07Z Heterogeneous Beliefs, Rare Disasters, and Asset Pricing Chen, Hui Joslin, Scott Stephen Walter Tran, Ngoc-Khanh Sloan School of Management Chen, Hui Chen, Hui Joslin, Scott Stephen Walter Tran, Ngoc-Khanh We illustrate the effects of heterogeneous beliefs about disasters on the equity premium and individual agents’ trading activities. When investors disagree about the chances or severity of disasters, those optimistic investors may insure the pessimists against their disaster risk exposure. Due to the highly non-linear relationship between the consumption losses during a disaster and the risk premium, a small amount of risk sharing can significantly attenuate the effect that disasters have on the equity premium. Thus, the equity premium will remain low even when the economy is predominantly occupied by pessimistic investors, but jump up following a disaster. The effects of risk sharing become stronger when the differences in beliefs are large, or when the optimistic agents also have lower risk aversion. Other interesting predictions of the model include a nonmonotonic relationship between the equity premium and the size of the disaster insurance market, as well as a negative relationship between the equity premium and the amount of disagreements about disasters. 2011-12-06T16:37:02Z 2011-12-06T16:37:02Z 2010-01 2009-12 Article http://purl.org/eprint/type/ConferencePaper 0065-812X http://hdl.handle.net/1721.1/67455 Chen, Hui, Scott Joslin and Ngoc-Khanh Tran. "Heterogeneous Beliefs, Rare Disasters, and Asset Pricing." in Papers of the Allied Social Science Associations, AEA Annual Meeting, January 2-5, 2010, Atlanta Marriott Marquis, Atlanta, GA, https://orcid.org/0000-0001-9605-641X en_US www.aeaweb.org/aea/conference/program/retrieve.php?pdfid=494 Papers of the Allied Social Science Associations Article is made available in accordance with the publisher's policy and may be subject to US copyright law. Please refer to the publisher's site for terms of use. application/pdf American Economic Association AEA |
| spellingShingle | Chen, Hui Joslin, Scott Stephen Walter Tran, Ngoc-Khanh Heterogeneous Beliefs, Rare Disasters, and Asset Pricing |
| title | Heterogeneous Beliefs, Rare Disasters, and Asset Pricing |
| title_full | Heterogeneous Beliefs, Rare Disasters, and Asset Pricing |
| title_fullStr | Heterogeneous Beliefs, Rare Disasters, and Asset Pricing |
| title_full_unstemmed | Heterogeneous Beliefs, Rare Disasters, and Asset Pricing |
| title_short | Heterogeneous Beliefs, Rare Disasters, and Asset Pricing |
| title_sort | heterogeneous beliefs rare disasters and asset pricing |
| url | http://hdl.handle.net/1721.1/67455 https://orcid.org/0000-0001-9605-641X |
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