NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

On the Size Distribution of Macroeconomic Disasters

Robert J. Barro, Tao Jin

NBER Working Paper No. 15247
Issued in August 2009
NBER Program(s):   AP   EFG   ME

In the rare-disasters setting, a key determinant of the equity premium is the size distribution of macroeconomic disasters, gauged by proportionate declines in per capita consumption or GDP. The long-term national-accounts data for up to 36 countries provide a large sample of disaster events of magnitude 10% or more. For this sample, a power-law density provides a good fit to the distribution of the ratio of normal to disaster consumption or GDP. The key parameter of the size distribution is the upper-tail exponent, α, estimated to be near 5, with a 95% confidence interval between 3-1/2 and 7. The equity premium involves a race between α and the coefficient of relative risk aversion, γ. A higher α signifies a thinner tail and, therefore, a lower equity premium, whereas a higher γ implies a higher equity premium. The equity premium is finite if α 1>γ. To accord with the observed average unlevered equity premium of around 5%, we get a point estimate for γ close to 3, with a 95% confidence interval of roughly 2 to 4.

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This paper was revised on December 5, 2011

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Document Object Identifier (DOI): 10.3386/w15247

Published: Robert J. Barro & Tao Jin, 2011. "On the Size Distribution of Macroeconomic Disasters," Econometrica, Econometric Society, vol. 79(5), pages 1567-1589, 09. citation courtesy of

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