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An Equilibrium Asset Pricing Model with Labor Market Search

  • Lars-Alexander Kuehn
  • Nicolas Petrosky-Nadeau
  • Lu Zhang

Search frictions in the labor market help explain the equity premium in the financial market. We embed the Diamond-Mortensen-Pissarides search framework into a dynamic stochastic general equilibrium model with recursive preferences. The model produces a sizeable equity premium of 4.54% per annum with a low interest rate volatility of 1.34%. The equity premium is strongly countercyclical, and forecastable with labor market tightness, a pattern we confirm in the data. Intriguingly, search frictions, combined with a small labor surplus and large job destruction flows, give rise endogenously to rare disaster risks a la Rietz (1988) and Barro (2006).

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17742.

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Date of creation: Jan 2012
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Handle: RePEc:nbr:nberwo:17742
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