Charles A. Dice Center Working Paper No. 2012-16
65 Pages Posted: 5 Sep 2012 Last revised: 26 May 2015
Date Written: May 20, 2015
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: 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