Abstract
In a general Stochastic Dynamic General Equilibrium framework, we first explicit an equilibrium relationship between (possibly) subjective assessments of the likelihood of drop in aggregate endowments, and next period equilibrium returns of financial assets. This relationship shows that the greater the anticipation of future drops in endowments, the greater the magnitude of the market crash. Using US market data for the 1961-2015 period, we first operationalize the definition of market crashes using an elasticity of variance definition. Using a Bayesian SVAR framework, we then highlight a positive impact of unexpected negative shocks of the yield curve on the likelihood of a stock market crash. These results are robust to different maturities of the yield curve and offer support to our theoretical insights.
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