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Asset Pricing with Endogenously Uninsurable Tail Risk

Author

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  • Hengjie Ai
  • Anmol Bhandari

Abstract

This paper studies asset pricing in a setting in which idiosyncratic risk in human capital is not fully insurable. Firms use long-term contracts to provide insurance to workers, but neither side can commit to these contracts; furthermore, worker-firm relationships have endogenous durations owing to costly and unobservable effort. Uninsured tail risk in labor earnings arises as a part of an optimal risk-sharing scheme. In the general equilibrium, exposure to the resulting tail risk generates higher risk premia, more volatile returns, and variations in expected returns across firms. Model outcomes are consistent with the cyclicality of factor shares in the aggregate, and the heterogeneity in exposures to idiosyncratic and aggregate shocks in the cross section.

Suggested Citation

  • Hengjie Ai & Anmol Bhandari, 2018. "Asset Pricing with Endogenously Uninsurable Tail Risk," Staff Report 570, Federal Reserve Bank of Minneapolis.
  • Handle: RePEc:fip:fedmsr:570
    DOI: 10.21034/sr.570
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    Cited by:

    1. Indrajit Mitra & Yu Xu, 2020. "Limited Household Risk Sharing: General Equilibrium Implications for the Term Structure of Interest Rates," FRB Atlanta Working Paper 2020-20, Federal Reserve Bank of Atlanta.

    More about this item

    Keywords

    Limited commitment; Equity premium puzzle; Tail risk; Dynamic contracting;
    All these keywords.

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • G1 - Financial Economics - - General Financial Markets

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