A representative-consumer model with Epstein-Zin-Weil preferences and i.i.d. shocks, including rare disasters, accords with key asset-pricing observations. The match with major features of asset pricing suggests that the model is a reasonable candidate for assessing the welfare cost of aggregate consumption uncertainty. In the baseline simulation, the welfare cost of disaster risk is large -- society would be willing to lower real GDP by as much as 20% each year to eliminate the small chance of major economic collapses.
Barro, R.J. (2008). "Rare Disasters, Asset Prices, and Welfare Costs." NBER Working Paper No. 13690, Dec 2007.
