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Identification of beliefs in the presence of disaster risk and misspecification
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Chaudhuri, Saraswata, Renault, Eric and Wahlstrom, Oscar (2023) Identification of beliefs in the presence of disaster risk and misspecification. In: Essays in Honor of Joon Y. Park: Econometric Methodology in Empirical Applications. Advances in Econometrics, 45B . Bingley: Emerald Publishing Limited, pp. 261-290. ISBN 9781837532131
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Official URL: https://doi.org/10.1108/S0731-90532023000045B012
Abstract
The authors discuss the econometric underpinnings of Barro (2006)'s defense of the rare disaster model as a way to bring back an asset pricing model “into the right ballpark for explaining the equity-premium and related asset-market puzzles.” Arbitrarily low-probability economic disasters can restore the validity of model-implied moment conditions only if the amplitude of disasters may be arbitrary large in due proportion. The authors prove an impossibility theorem that in case of potentially unbounded disasters, there is no such thing as a population empirical likelihood (EL)-based model-implied probability distribution. That is, one cannot identify some belief distortions for which the EL-based implied probabilities in sample, as computed by Julliard and Ghosh (2012), could be a consistent estimator. This may lead to consider alternative statistical discrepancy measures to avoid the problem with EL. Indeed, the authors prove that, under sufficient integrability conditions, power divergence Cressie-Read measures with positive power coefficients properly define a unique population model-implied probability measure. However, when this computation is useful because the reference asset pricing model is misspecified, each power divergence will deliver different model-implied beliefs distortion. One way to provide economic underpinnings to the choice of a particular belief distortion is to see it as the endogenous result of investor's choice when optimizing a recursive multiple-priors utility a la Chen and Epstein (2002). Jeong et al. (2015)'s econometric study confirms that this way of accommodating ambiguity aversion may help to address the Equity Premium puzzle.
Item Type: | Book Item | ||||||
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Subjects: | H Social Sciences > HB Economic Theory | ||||||
Divisions: | Faculty of Social Sciences > Economics | ||||||
Library of Congress Subject Headings (LCSH): | Econometrics, Robust statistics, Econometric models, Financial crises -- Econometric models, Equilibrium (Economics) -- Mathematical models, Risk -- Econometric models | ||||||
Series Name: | Advances in Econometrics | ||||||
Publisher: | Emerald Publishing Limited | ||||||
Place of Publication: | Bingley | ||||||
ISBN: | 9781837532131 | ||||||
ISSN: | 0731-9053 | ||||||
Book Title: | Essays in Honor of Joon Y. Park: Econometric Methodology in Empirical Applications | ||||||
Official Date: | 24 April 2023 | ||||||
Dates: |
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Volume: | 45B | ||||||
Page Range: | pp. 261-290 | ||||||
DOI: | 10.1108/S0731-90532023000045B012 | ||||||
Status: | Peer Reviewed | ||||||
Publication Status: | Published | ||||||
Reuse Statement (publisher, data, author rights): | © Emerald Publishing Limited. This AAM is provided for your own personal use only. It may not be used for resale, reprinting, systematic distribution, emailing, or for any other commercial purpose without the permission of the publisher. | ||||||
Access rights to Published version: | Restricted or Subscription Access | ||||||
Date of first compliant deposit: | 1 March 2022 | ||||||
Date of first compliant Open Access: | 28 July 2023 | ||||||
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