Premium
Rare disaster risk and the expected equity risk premium
Author(s) -
Berkman Henk,
Jacobsen Ben,
Lee John B.
Publication year - 2017
Publication title -
accounting and finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.645
H-Index - 49
eISSN - 1467-629X
pISSN - 0810-5391
DOI - 10.1111/acfi.12158
Subject(s) - equity premium puzzle , risk premium , economics , proxy (statistics) , market risk , capital asset pricing model , dividend , volatility risk premium , financial economics , econometrics , equity (law) , stock market , liquidity premium , monetary economics , volatility (finance) , liquidity risk , implied volatility , finance , statistics , paleontology , mathematics , horse , political science , market liquidity , law , biology
Consistent with the predictions of rare disaster models, we find that a proxy for the time‐varying probability of rare disasters helps to explain fluctuations in expectations of the equity risk premium. Our proxy for disaster risk is a recently developed measure of global political instability, and the expected market risk premium is from V alue L ine analysts' expected stock returns. Consistent with long‐run risk models, uncertainty about expected GDP growth and expected consumption growth is also significantly positively related to the expected market risk premium. We obtain similar results when we use the earnings–price ratio and the dividend–price ratio as proxies for the expected market risk premium.