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Rietz Study Cited in Disaster Risk Commentary

An allowance for varying probabilities of disaster events may explain a lot of riddles in the study of finance. In an article, THOMAS RIETZ of the University of Iowa argued that the high equity premium and the low risk-free real interest rate could be explained by fears of low-probability disaster events, such as a depression. People are risk-averse and try to protect themselves against a collapse of stocks in bad economic times. In his version of Reitz's theory, Robert J. Barrois, a professor of economics at Harvard University, says the average equity premium suggests that the Rietz thesis explains not only the high equity premium and low risk-free rate but also several other conundrums, including the volatility of stock prices.

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