Asset Pricing under Rational Learning about Rare Disasters

Date: 2023-11-20, Monday  
Time: 11:40-13:00 (Budapest time)  
Venue: Corvinus Main Building, E.III. (ground floor) 

Organizer: Institute of Finance  

Event: Research Seminar by Dr. Christos Koulovatianos 

Title: Asset Pricing under Rational Learning about Rare Disasters 

Abstract: Why is investment in stocks so persistently weak after a rare disaster? Connecting disaster episodes with post-disaster expectations seems crucial for such post-disaster forecasting and also policymaking, but rational-expectations models with variable disaster risk often fail to achieve this connection. To this end, while retaining full rationality, we introduce limited information and learning about rare-disaster risk and show that the resulting stock-investment behavior seems similar to persistent investor fear after a rare disaster. We study (a) rational learning for state verification (RLS), with investors knowing the data-generating process of disaster riskiness but being unable to observe whether the economy is in a riskier state (regime) or not, and (b) rational learning about the data-generating process (RLP) of disaster risk, with investors also being unaware of the data-generating process of disaster riskiness. We analytically show that both RLS and RLP synchronize disaster events with post-disaster expectations and asset prices, and create persistence in price-dividend ratios even if data-generating processes of disaster risk have no persistence. Using De Finetti’s theorem we show that RLP offers an explanation for global spells of pessimism and weak investment after a disaster. 
Joint paper with Volker Wieland (Goethe U Frankfurt). 

Click here to access the author’s website. 

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