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On the effects of pessimism toward pollution-driven disasters on equity premiums

Author

Listed:
  • Shiba Suzuki

    (Seikei University
    SOAS University of London)

  • Hiroaki Yamagami

    (Seikei University)

Abstract

This study explores how investors’ subjective perception of pollution-driven disasters affects asset prices. Environmental pollution resulting from economic activities raises the probability of disasters. However, the relationship between economic activity and pollution-driven disasters is difficult to ascertain. Thus, investors make decisions based on subjective expectations; they subjectively evaluate the probability of disasters pessimistically. We investigate whether a pessimistic perception toward pollution-driven disasters causes high equity premiums by deriving a closed-form solution for the equity premium under a Markov process. Our contribution is to demonstrate that pessimism magnifies the equity premium even when the intertemporal elasticity of substitution is slightly lower than 1, which is empirically plausible.

Suggested Citation

  • Shiba Suzuki & Hiroaki Yamagami, 2024. "On the effects of pessimism toward pollution-driven disasters on equity premiums," Economic Theory Bulletin, Springer;Society for the Advancement of Economic Theory (SAET), vol. 12(2), pages 167-181, December.
    • Handle: RePEc:spr:etbull:v:12:y:2024:i:2:d:10.1007_s40505-024-00270-0
    DOI: 10.1007/s40505-024-00270-0
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