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Variable Rare Disasters: An Exactly Solved Framework for Ten Puzzles in Macro-Finance *
Quarterly Journal of Economics
This paper incorporates a time-varying intensity of disasters in the Rietz-Barro hypothesis that risk premia result from the possibility of rare, large disasters. During a disaster, an asset's fundamental value falls by a time-varying amount. This in turn generates time-varying risk premia and thus volatile asset prices and return predictability. Using the recent technique of linearity-generating processes (Gabaix 2007), the model is tractable, and all prices are exactly solved in closed form.doi:10.1093/qje/qjs001 fatcat:xw6qtizprfeotiwqhi4euxayb4