Year: 2007
Type: report
Abstract: 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.
DOI: 10.3386/w13690
Author: Robert Barro
Institutions: National Bureau of Economic Research, Harvard University
Language: English
Topic: Economic theories and models
Subfield: Economics and Econometrics
Domain: Social Sciences
Open Access status: green
Funder: National Science Foundation
OpenAlex ID: W2038433189