Climbing and Falling Off the Ladder: Asset Pricing Implications of Labor Market Event Risk
From Lawrence Schmidt
Administrative earnings data reveal that households are exposed to large, countercyclical idiosyncratic tail risks in labor earnings. I illustrate how these risks affect asset prices within an asset pricing framework with recursive preferences, heterogeneous agents and incomplete markets. Quantitatively, a model in which agents face a time-varying probability of experiencing a rare, idiosyncratic disaster, with parameters disciplined by data, matches the level and dynamics of the equity premium. Stock returns are highly informative about labor market event risk, and, consistent with model predictions, initial claims for unemployment, a proxy for labor market uncertainty, is a highly robust predictor of returns.
Lawrence D. W. Schmidt
Victor J. Menezes (1972) Career Development Assistant Professor of Finance
Featured Publication
Schmidt, Lawrence D.W., MIT Sloan Working Paper 5500-16. Cambridge, MA: MIT Sloan School of Management, March 2022.
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