Aggregate Asset Pricing with Labor Market Frictions
Even though labor income represents about two thirds of disposal income to household, its role has largely been neglected by asset pricing models. In this paper, we solve a general equilibrium model which can both rationalize important feature of labor markets as well as financial markets. To this end, we embed labor market search frictions into a business cycle model where the representative household has recursive Epstein-Zin preferences. We find that the model is consistent with the cyclical behavior of the unemployment rate. The model also replicates the volatility of labor market tightness seen in the data. Crucially, for asset prices, aggregate employment and output react progressively to innovations and the model delivers a high degree of persistence in the growth rate of aggregate output and consumption. This endogenous persistence in combination with recursive Epstein-Zin preferences increase the equity risk premium considerably.
|Date of creation:||2010|
|Date of revision:|
|Contact details of provider:|| Postal: Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA|
Web page: http://www.EconomicDynamics.org/
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- Cochrane, John H. & Campbell, John, 1999.
"By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior,"
3119444, Harvard University Department of Economics.
- John Y. Campbell & John H. Cochrane, 1994. "By force of habit: a consumption-based explanation of aggregate stock market behavior," Working Papers 94-17, Federal Reserve Bank of Philadelphia.
- John Y. Campbell & John H. Cochrane, 1994. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," CRSP working papers 412, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
- John Y. Campbell & John H. Cochrane, 1995. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," NBER Working Papers 4995, National Bureau of Economic Research, Inc.
- John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April.
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