Rare disaster probability and options pricing

Barro, Robert J.; Liao, Gordon Y.

doi:10.1016/j.jfineco.2020.10.001

Cited by 36 publications

(21 citation statements)

References 38 publications

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“…Parameters set without solving the model. Beginning in the upper panel of Table 1, the coefficient of relative risk aversion is σ = 3, consistent with the Barro and Liao (2021) choice of σ and our implementation of their methodology for recovering the aggregate disaster probability. Using their methodology, we estimate ϕ a = 0.24 so that the economy scales down by exp(−ϕ a ) = 0.79 conditional on an aggregate disaster.…”

Section: Parameterizationsupporting

confidence: 64%

“…We choose 12 months as it is the maximum duration of regular unemployment benefits. For the aggregate disaster probability π a , we follow Barro and Liao (2021) and use prices of far-out-of-the-money put options. A far-out-of-the-money put option pays off only when stock prices fall by a significant amount, so the price of such an option provides information about the probability a disaster occurs (in which case the option becomes in the money), the size of a disaster conditional on one occurring, and risk aversion.…”

Section: Driving Forcesmentioning

confidence: 99%

“…A far-out-of-the-money put option pays off only when stock prices fall by a significant amount, so the price of such an option provides information about the probability a disaster occurs (in which case the option becomes in the money), the size of a disaster conditional on one occurring, and risk aversion. Appendix B.6 details our implementation of the Barro and Liao (2021) procedure for Greece. We estimate monthly averages of daily disaster probabilities and then annualize and average in a year to arrive at our series for π a in Figure 3(i).…”

Section: Driving Forcesmentioning

confidence: 99%

“…Thus, we can alternatively obtain log deviations of āT from subsectors of tradables. We follow Barro and Liao (2021) to recover the time series of disaster probabilities π a t from prices of far-out-of-the-money put options. Important assumptions in the Barro and Liao (2021) model are: (i) a representative agent with Epstein-Zin preferences; (ii) a downward jump component in the process for output; and (iii) a power law distribution of output loss conditional on a downward jump occurring.…”

Section: B5 Alternative Measures Of Exports and External Demandmentioning

confidence: 99%

See 3 more Smart Citations

The Macroeconomics of the Greek Depression

Chodorow-Reich¹,

Karabarbounis²,

Kekre³

2019

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The Greek economy has experienced three distinct phases in the past 20 years: a boom from 1999 to 2007, a crash from 2007 to 2012, and a flattening from 2012 to 2017. We explore these dynamics using a quantitative model of a two-sector small open economy with nominal frictions, collateral constraints, and endogenous utilization. We first evaluate the roles of shocks to productivity, financial conditions, fiscal policy, external demand, and disaster risk in contributing to the cycle. We then ask whether counterfactual policies such as an unexpected devaluation or an alternative mix of fiscal adjustments could have facilitated the recovery.

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Section: Parameterizationsupporting

confidence: 64%

Section: Driving Forcesmentioning

confidence: 99%

Section: Driving Forcesmentioning

confidence: 99%

Section: B5 Alternative Measures Of Exports and External Demandmentioning

confidence: 99%

See 2 more Smart Citations

The Macroeconomics of the Greek Depression

Chodorow-Reich¹,

Karabarbounis²,

Kekre³

2019

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“…Out-of-the-money options have been used in prior studies to gauge rare disaster risk (Farhi and Gabaix, 2016;Barro and Liao, 2020) and currency crash risks (Farhi, Fraiberger, Gabaix, Ranciere, and Verdelhan, 2009;Chernov, Graveline, and Zviadadze, 2018;Jurek, 2014). Our…”

Section: Hedged Demand and Options-pricingmentioning

confidence: 99%

The Hedging Channel of Exchange Rate Determination

Liao

Zhang

2020

SSRN Journal

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We document the exchange rate hedging channel that connects country-level measures of net external financial imbalances with exchange rates. In times of market distress, countries with large positive external imbalances (e.g. Japan) experience domestic currency appreciation, and crucially, forward exchange rates appreciate relatively more than the spot after adjusting for interest rate differentials. Countries with large negative foreign asset positions experience the opposite currency movements. We present a model demonstrating that exchange rate hedging coupled with intermediary constraints can explain these observed relationships between net external imbalances and spot and forward exchange rates. We find empirical support for this currency hedging channel of exchange rate determination in both the conditional and unconditional moments of exchange rates, option prices, large institutional investors' disclosure of hedging activities, and central bank swap line usage during the COVID-19 market turmoil.

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Robert J. Barro (1944–)

Young

2024

The Palgrave Companion to Harvard Economics

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Rare disaster probability and options pricing

Cited by 36 publications

References 38 publications

The Macroeconomics of the Greek Depression

The Macroeconomics of the Greek Depression

The Hedging Channel of Exchange Rate Determination

Robert J. Barro (1944–)

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