00:00:05
So my research links economywide
00:00:08
disasters to asset prices like stock
00:00:11
prices for example. Um this is research
00:00:14
that I along with others have been
00:00:17
pursuing recently say it's it's really
00:00:20
um taken off over the last five years
00:00:22
and it's certainly gotten a boost from
00:00:24
the financial crisis.
00:00:26
uh and in this research um part of it
00:00:31
draws on historical data on consumption
00:00:33
disasters from the United States and
00:00:35
from elsewhere in the world. An example
00:00:38
of a consumption disaster is the Great
00:00:39
Depression where consumption fell by
00:00:42
20%. Um but that's actually a relatively
00:00:45
minor disaster. If you look at Europe,
00:00:48
um after the Second World War, many
00:00:49
countries had economies that contracted
00:00:51
by as much as 50%. Um if stock prices
00:00:55
fall in the event of a disaster then
00:00:58
that is an important risk that investors
00:01:01
take into account and that can explain
00:01:03
why in normal times we have such high
00:01:06
returns on stock prices which has long
00:01:09
been a puzzle. It can also explain why
00:01:11
stock prices are so volatile because
00:01:13
this risk is hard to calculate and very
00:01:16
hard to measure and as investors
00:01:18
perceptions of it move around that can
00:01:20
move around stock prices.
00:01:26
So the first takeaway is that the world
00:01:29
is risky that there are there are these
00:01:32
risks for consumption disasters and they
00:01:35
are that's reflected in stock prices and
00:01:37
that's why we see such a high realized
00:01:40
return during normal times when we don't
00:01:42
have
00:01:43
disasters. Also one of the reasons that
00:01:46
stock returns are so volatile is because
00:01:48
of these fears of a disaster. Now, you
00:01:51
might think of these fears as
00:01:52
overreaction because often the disaster
00:01:54
doesn't happen. However, is it
00:01:56
overreaction or do people really have a
00:01:59
reason to be afraid? Certainly, in 2008,
00:02:01
it seemed like we had a reason to be
00:02:08
afraid. Well, stock market volatility
00:02:10
has been a puzzle for a long time. So
00:02:13
what surprised me is that when we put
00:02:16
the um information this international
00:02:18
data from disasters into a model that
00:02:22
this really could explain the magnitudes
00:02:24
of stock market volatility that we see.
00:02:27
Part of it is investors risk aversion.
00:02:30
So when you have numbers like even a
00:02:33
small probability of a 50% decline or
00:02:36
even a 20% decline that really
00:02:38
influences investors behavior.
00:02:44
Unfortunately, I think some people have
00:02:47
a wishful thinking view of the stock
00:02:49
market that if you just hold on long
00:02:52
enough that you're guaranteed to get
00:02:54
some of the high rates of return that
00:02:56
we've measured over the post-war period,
00:02:59
these rates of return being 12% that
00:03:03
this is just something you're going to
00:03:05
get if you keep holding stocks. Well,
00:03:07
that may not be true. Now this is not a
00:03:09
measure that investors shouldn't hold
00:03:11
stocks. I I hold stocks and I think for
00:03:14
investors who have positive net worth
00:03:16
stocks are an important part of the
00:03:17
portfolio. But in evaluating the risk
00:03:21
they could go down and they might not
00:03:22
come back
00:03:27
up. So one of them is for investors that
00:03:32
investors should be aware that stocks
00:03:33
are risky um that and that the return is
00:03:36
not guaranteed. What this means um is
00:03:40
not that you shouldn't hold stocks. It's
00:03:43
just that given that stocks might go
00:03:46
down, holding stocks in say an
00:03:48
environment where you also have leverage
00:03:51
is is putting yourself under a certain
00:03:53
amount of risk. Leverage could include
00:03:56
um a mortgage. leverage might include a
00:04:01
job employ or employment of some kind
00:04:03
where your income is very much um
00:04:06
subject to the stock market. Those might
00:04:08
be reasons to limit the stock market
00:04:11
part the stock part of your portfolio
00:04:14
beyond what say just these wonderful
00:04:16
expected returns would indicate. That's
00:04:19
number one. Number
00:04:21
two, these concerns about rare disasters
00:04:24
have been part of what's been pricing
00:04:28
stocks for a long time. And to me, that
00:04:31
suggests caution on the part of
00:04:34
regulators um because I think it's just
00:04:38
going to be very hard to eliminate this
00:04:40
risk. Part of what might be driving
00:04:42
events like 2008 are fears about future
00:04:46
growth
00:04:47
prospects and those that those kind of
00:04:52
fears are very hard to eliminate. So if
00:04:54
you can't eliminate those fears, you can
00:04:56
make the economy less risky by say um
00:05:01
having less leverage on the part of
00:05:03
financial
00:05:05
institutions.
00:05:08
People have been researching the stock
00:05:10
market for a long time. What sets this
00:05:13
line of research apart is the focus on
00:05:15
these tail events. And um we don't
00:05:20
assume for example that risk is normally
00:05:22
distributed. Now that's a technical
00:05:25
term. Um what the normal distribution
00:05:27
apply implies is something called the
00:05:29
bell curve. And the bell curve has thin
00:05:32
tails for outcomes. So it basically
00:05:35
means that risky things are unlikely to
00:05:38
happen and it means that risk is very
00:05:40
easily measured. So you can if you think
00:05:43
that risk follows this bell curve, you
00:05:46
can almost fool yourself into thinking
00:05:48
that you've you understand everything
00:05:50
about risk when in fact there are these
00:05:53
rare events that are out there, not that
00:05:55
far out there. They're still we see them
00:05:57
in the Great Depression.
00:05:59
Um but they can have an important part
00:06:02
effect on stock prices if you introduce
00:06:04
them into investors
00:06:10
beliefs. I'm looking into links with the
00:06:13
macroeconomy. Um so employment and
00:06:15
unemployment is my um biggest focus
00:06:18
right now. So, we're writing down a
00:06:20
model that can explain why um
00:06:23
unemployment and job vacancies are so
00:06:26
volatile even though consumption itself
00:06:28
is very
00:06:29
smooth and why these things might track
00:06:32
the stock market because recently they
00:06:34
have tracked the stock market and a big
00:06:37
part of it is like investing in the
00:06:40
stock market. Investing in hiring is
00:06:42
something where you need confidence that
00:06:45
the economy is going to be stable going
00:06:47
forward. If you lack that confidence,
00:06:48
you don't want to put forth this
00:06:50
investment.
00:06:54
[Music]
