How does contagion affect general equilibrium asset prices? : [Version: March 13, 2013]

  • This paper analyzes the equilibrium pricing implications of contagion risk in a Lucas-tree economy with recursive preferences and jumps. We introduce a new economic channel allowing for the possibility that endowment shocks simultaneously trigger a regime shift to a bad economic state. We document that these contagious jumps have far-reaching asset pricing implications. The risk premium for such shocks is superadditive, i.e. it is 2.5\% larger than the sum of the risk premia for pure endowment shocks and regime switches. Moreover, contagion risk reduces the risk-free rate by around 0.5\%. We also derive semiclosed-form solutions for the wealth-consumption ratio and the price-dividend ratios in an economy with two Lucas trees and analyze cross-sectional effects of contagion risk qualitatively. We find that heterogeneity among the assets with respect to contagion risk can increase risk premia disproportionately. In particular, big assets with a large exposure to contagious shocks carry significantly higher risk premia.

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Author:Nicole BrangerORCiDGND, Holger KraftGND, Christoph MeinerdingORCiDGND
Parent Title (German):SAFE working paper series ; No. 11
Series (Serial Number):SAFE working paper series (11)
Publisher:Goethe-Univ., House of Finance, Sustainable Architecture for Finance in Europe, SAFE
Place of publication:Frankfurt am Main
Document Type:Working Paper
Year of Completion:2013
Year of first Publication:2013
Publishing Institution:Universit├Ątsbibliothek Johann Christian Senckenberg
Release Date:2013/04/19
Tag:Asset Pricing; Contagion; General Equilibrium; Recursive Preferences
Issue:version: March 13, 2013
Page Number:60
Institutes:Wirtschaftswissenschaften / Wirtschaftswissenschaften
Wissenschaftliche Zentren und koordinierte Programme / House of Finance (HoF)
Wissenschaftliche Zentren und koordinierte Programme / Center for Financial Studies (CFS)
Dewey Decimal Classification:3 Sozialwissenschaften / 33 Wirtschaft / 330 Wirtschaft
Licence (German):License LogoDeutsches Urheberrecht