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Wage Rigidity: A Quantitative Solution to Several Asset Pricing Puzzles

Charles A. Dice Center Working Paper No. 2012-16

Fisher College of Business Working Paper No. 2012-03-016

65 Pages Posted: 5 Sep 2012 Last revised: 26 May 2015

Jack Y Favilukis

University of British Columbia (UBC) - Division of Finance

Xiaoji Lin

Ohio State University (OSU) - Fisher College of Business

Multiple version iconThere are 2 versions of this paper

Date Written: May 20, 2015

Abstract

In standard production models wage volatility is far too high and equity volatility is far too low. A simple modification - sticky wages due to infrequent resetting together with a CES production function - leads to both (i) smoother wages and (ii) higher equity volatility. Furthermore, the model produces several other hard to explain features of financial data: (iii) high Sharpe ratios, (iv) low and smooth interest rates, (v) time-varying equity volatility and premium, (vi) a value premium, and (vii) a downward-sloping equity term structure. Pro-cyclical, volatile wages are a hedge for firms in standard models, smoother wages act like operating leverage, making profits and dividends more risky.

Keywords: Wage Rigidity, Equity Volatility, Equity Premium, General Equilibrium, Production-Based Asset Pricing, Value Premium

JEL Classification: E21, E23, E32, E44, G12

Suggested Citation

Favilukis, Jack Y and Lin, Xiaoji, Wage Rigidity: A Quantitative Solution to Several Asset Pricing Puzzles (May 20, 2015). Charles A. Dice Center Working Paper No. 2012-16; Fisher College of Business Working Paper No. 2012-03-016. Available at SSRN: https://ssrn.com/abstract=2141275 or http://dx.doi.org/10.2139/ssrn.2141275

Jack Y Favilukis

University of British Columbia (UBC) - Division of Finance ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada

Xiaoji Lin (Contact Author)

Ohio State University (OSU) - Fisher College of Business ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States

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