Satisfactory calculations of the welfare cost of aggregate consumption uncertainty
require a framework that replicates major features of asset prices and returns, such
as the high equity premium and low risk-free rate. A Lucas-tree model with rare but
large disasters is such a framework. In a baseline simulation, the welfare cost of
disaster risk is large - society would be willing to lower real GDP by about 20%
each year to eliminate all disaster risk, including wars. In contrast, the welfare
cost from usual economic fluctuations is much smaller, though still important - corresponding
to lowering GDP by around 1.5% each year.