Do Investors Pay Attention to Rare Disaster Risk? Evidence from Earthquake Risk in Japanese Real Estate Investment Trust Market

The financial economics literature suggests that the possibility of rare events occurring affects asset pricing dynamics. At the same time, the recent finance literature found that investors often pay only limited attention to relevant information in making their investment decisions and they shift attention allocation once notable events occur.Our study builds upon past asset pricing literature discussing both rare disaster risk and limited attention by first examining the effects of investor attention/inattention to rare disaster risk on asset pricing dynamics. We utilize the earthquake events that have occurred in Japan during the past 10 years as rare disasters and examine their impacts on asset price dynamics within the Japanese Real Estate Investment Trust (J-REITs). Specifically, we study the relationship between the changes in perceived earthquake risk and the J-REITs' stock returns to examine if perceived earthquake risk is priced in J-REIT stocks. We then examine investor attention/inattention to the earthquake risk and its effects on stock returns in two ways. Firstly, we test whether the relationship between the changes in perceived earthquake risk and the J-REITs' stock returns differs based on the published earthquake risk measure of individual J-REITs, called Probable Maximum Loss (PML) during the past 10 years. Secondly, we focus on price movements after the starts of earthquake events to examine if investors alter their attention allocation once earthquake events provoke their fear and awareness of earthquake events. The relationship between rare disaster risk and stock returns has been only recently empirically examined in the finance literature. However, the literature has provided no direct empirical support for the assertion that investors actually pay attention to rare disaster risk. Thus, our study will shed new light on the discussions on the effects of rare disaster risk and the impacts of investors' limited attention on asset pricing dynamics by examining the interrelationship between these two concepts. This study also contributes to the REIT literature, revealing how earthquake risk is priced in REITs in earthquake-prone countries. This is important, since more and more REIT markets are being developed in several countries, notably in some Asian countries that are prone to earthquakes.