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Wage Rigidity: A Solution to Several Asset Pricing Puzzles

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  • Favilukis, Jack

    (London School of Economics and Political Science)

  • Lin, Xiaoji

    (OH State University)

Abstract

In standard models wages are too volatile and returns too smooth. We make wages sticky through infrequent resetting, resulting in both (i) smoother wages and (ii) volatile returns. Furthermore, the model produces other puzzling features of financial data: (iii) high Sharpe Ratios, (iv) low and smooth interest rates, (v) time-varying equity volatility and premium, and (vi) a value premium. In standard models, highly pro-cyclical and volatile wages are a hedge. The residual profit becomes unrealistically smooth, as do returns. Smoother wages act like operating leverage, making profits more risky. Bad times and unproductive firms are especially risky because committed wage payments are high relative to output.

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Paper provided by Ohio State University, Charles A. Dice Center for Research in Financial Economics in its series Working Paper Series with number 2012-16.

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Date of creation: Sep 2012
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Handle: RePEc:ecl:ohidic:2012-16

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  1. Leena Rudanko, 2005. "Labor Market Dynamics under Long Term Wage Contracting," 2005 Meeting Papers 876, Society for Economic Dynamics.
  2. Lars-Alexander Kuehn & Nicolas Petrosky-Nadeau & Lu Zhang, 2012. "An Equilibrium Asset Pricing Model with Labor Market Search," NBER Working Papers 17742, National Bureau of Economic Research, Inc.
  3. R?diger Bachmann & Ricardo J. Caballero & Eduardo M. R. A. Engel, 2013. "Aggregate Implications of Lumpy Investment: New Evidence and a DSGE Model," American Economic Journal: Macroeconomics, American Economic Association, vol. 5(4), pages 29-67, October.
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Cited by:
  1. Kuehn Lars-Alexander & Petrosky-Nadeau Nicolas & Zhang Lu, . "An Equilibrium Asset Pricing Model with Labor Market Search," GSIA Working Papers 2010-E63, Carnegie Mellon University, Tepper School of Business.
  2. Robert E. Hall, 2014. "High Discounts and High Unemployment," NBER Working Papers 19871, National Bureau of Economic Research, Inc.

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