Satisfactory calculations of the welfare cost of aggregate consumption uncertainty require a framework that replicates major features of asset prices and returns, such as the high equity premium and low risk-free rate. A Lucas-tree model with rare but large disasters is such a framework. In the baseline simulation, the welfare cost of disaster risk is large—society would be willing to lower real GDP by about 20% each year to eliminate all disaster risk. In contrast, the welfare cost from usual economic fluctuations is much smaller, though still important—corresponding to lowering GDP by around 1.5% each year.
The potential for rare economic disasters explains a lot of asset-pricing puzzles. I calibrate disaster probabilities from the twentieth century global history, especially the sharp contractions associated with World War I, the Great Depression, and World War II. The puzzles that can be explained include the high equity premium, low risk-free rate, and volatile stock returns. Another mystery that may be resolved is why expected real interest rates were low in the United States during major wars, such as World War II. The model, an extension of Rietz , maintains the tractable framework of a representative agent, time-additive and iso-elastic preferences, and complete markets. The results hold with i.i.d. shocks to productivity growth in a Lucas-tree type economy and also with the inclusion of capital formation.
For 188 independent countries in 2000, 72 had no state religion in 2000, 1970, and 1900; 58 had a state religion at all three dates; and 58 had some kind of transition. Among the 58 transitional countries, 12 had 2 transitions, 4 of which (former Soviet Republics in Asia) involved different forms of state religion. We use a Hotelling-type spatial competition model with a distribution of religion preferences to think about when the religion market would be monopolized. In this model, we can assess how changes in exogenous variables affect the likelihood of monopoly. We argue that these predictions carry over to a political setting in which the government decides whether to institute a state religion.