Disasters Risk and Business Cycles

No 15399, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: To construct a business cycle model consistent with the observed behavior of asset prices, and study the effect of shocks to aggregate uncertainty, I introduce a small, time-varying risk of economic disaster in a standard real business cycle model. The paper establishes two simple theoretical results: first, when the probability of disaster is constant, the risk of disaster does not affect the path of macroeconomic aggregates - a "separation theorem" between macroeconomic quantities and asset prices in the spirit of Tallarini (2000). Second, shocks to the probability of disaster, which generate variation in risk premia over time, are observationally equivalent to preference shocks. An increase in the perceived probability of disaster leads to a collapse of investment and a recession, an increase in risk spreads, and a decrease in the yield on safe assets. To assess the empirical validity of the model, I infer the probability of disaster from observed asset prices and feed it into the model. The variation over time in this probability appears to account for a significant fraction of business cycle dynamics, especially sharp downturns in investment and output such as 2008-IV.

JEL-codes: E32 E44 G12 (search for similar items in EconPapers)
Date: 2009-10
New Economics Papers: this item is included in nep-bec, nep-dge and nep-mac
Note: AP EFG ME
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (20)

Published as Francois Gourio, 2012. "Disaster Risk and Business Cycles," American Economic Review, American Economic Association, vol. 102(6), pages 2734-66, October.

Downloads: (external link)
http://www.nber.org/papers/w15399.pdf (application/pdf)

Related works:
Journal Article: Disaster Risk and Business Cycles (2012)
Working Paper: Disaster risk and business cycles (2009)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:nbr:nberwo:15399

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w15399

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().