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Labor Heterogeneity and Asset Prices: The Importance of Skilled Labor

  • Belo, Frederico

    (University of MN)

  • Lin, Xiaoji

    (OH State University)

We show that heterogeneity in the composition of the labor force affects asset prices in financial markets in important ways. Theoretically, we combine a standard model of labor heterogeneity (Acemoglu, 2002) with a standard neoclassical q-theory model with labor adjustment costs. We then show that the negative expected return-hiring rate relation documented in previous studies is steeper in industries with higher labor adjustment costs. Using the overall industry level of labor skill as a proxy for the industry specific size of labor adjustment costs, we provide empirical support for this prediction. The negative expected return-hiring rate relation is twice as large among industries with higher labor skills than in industries with lower labor skills. In addition, we uncover a novel unconditional labor skill return spread. Firms in industries with more skilled labor have on average higher stock returns than firms in industries with low skilled labor, but this difference is only large across small firms. According to this result, firms with higher labor skills labor tend to be more risky because skilled labor is more costly to adjust, which in turn affects the firm's sensitivity to aggregate shocks in the economy.

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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 2012-25.

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Date of creation: Nov 2012
Date of revision:
Handle: RePEc:ecl:ohidic:2012-25
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