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Real(istic) Time-Varying Probability of Consumption Disasters

Published online by Cambridge University Press:  24 November 2025

Xiaoyu Huang ,
Tao Jin  and
Hao Zhou
Xiaoyu Huang
Affiliation:
Wuhan University of Technology School of Economics xiaoyu.huang@whut.edu.cn
Tao Jin*
Affiliation:
Capital University of Economics and Business , Tsinghua University Hang Lung Center for Real Estate & PBC School of Finance, and Zhongnan University of Economics and Law Wenlan School of Business
Hao Zhou
Affiliation:
Tsinghua University PBC School of Finance, and Southern University of Science and Technology School of Business zhouh@pbcsf.tsinghua.edu.cn
*
tjin2007@gmail.com (corresponding author)
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Abstract

We model the time-varying probability of consumption disasters with international risk interactions and estimate the model using national accounts data of 42 countries back to 1833. The estimated world and country-specific disaster probabilities accord well with historical macroeconomic disasters. A match of the equity premium requires a relative risk aversion coefficient of approximately 5, which is significantly lower than previous estimates. Furthermore, the model provides notably better fits for equity volatility compared with alternative rare-disaster models. Finally, the disaster probability index estimated from the model demonstrates significant out-of-sample predictive power over long horizons, performing well not only over time but also across countries.

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Type
Research Article
Information
Journal of Financial and Quantitative Analysis , First View , pp. 1 - 35
Copyright
© The Author(s), 2025. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

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Footnotes

We appreciate helpful comments from an anonymous referee, Robert Barro, Yinxiao Chu, Thierry Foucault (the editor), Xavier Gabaix, Keyu Jin, Zhan Shi, George Tauchen, Jianfeng Yu, and Xiaoyan Zhang. We are grateful to Gordon Liao and Jessica Wachter for kindly sharing their data with us. Thanks also go to seminar participants in the 2019 Risk Management Conference at NUS and the PBC School of Finance at Tsinghua University. All errors are our own.

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