Wachter, Jessica A2023-05-222023-05-222013-06-012016-06-10https://repository.upenn.edu/handle/20.500.14332/34412Why is the equity premium so high, and why are stocks so volatile? Why are stock returns in excess of government bill rates predictable? This paper proposes an answer to these questions based on a time-varying probability of a consumption disaster. In the model, aggregate consumption follows a normal distribution with low volatility most of the time, but with some probability of a consumption realization far out in the left tail. The possibility of this poor outcome substantially increases the equity premium, while time-variation in the probability of this outcome drives high stock market volatility and excess return predictability.This is the peer reviewed version of the following article, which has been published in final form at http://dx.doi.org/10.1111/jofi.12018. This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Self-Archiving.FinanceFinance and Financial ManagementArticle