Climbing and Falling Off the Ladder: Asset Pricing Implications of Labor Market Event Risk

120 Pages Posted: 26 Jul 2014 Last revised: 21 Mar 2022

Date Written: March 2022

Abstract

Administrative earnings data reveal that households are exposed to large, countercyclical idiosyncratic tail risks in labor earnings. I illustrate how these risks affect asset prices within an asset pricing framework with recursive preferences, heterogeneous agents and incomplete markets. Quantitatively, a model in which agents face a time-varying probability of experiencing a rare, idiosyncratic disaster, with parameters disciplined by data, matches the level and dynamics of the equity premium. Stock returns are highly informative about labor market event risk, and, consistent with model predictions, initial claims for unemployment, a proxy for labor market uncertainty, is a highly robust predictor of returns.

Suggested Citation

Schmidt, Lawrence, Climbing and Falling Off the Ladder: Asset Pricing Implications of Labor Market Event Risk (March 2022). Available at SSRN: https://ssrn.com/abstract=2471342 or http://dx.doi.org/10.2139/ssrn.2471342

Lawrence Schmidt (Contact Author)

MIT Sloan School of Management ( email )

77 Massachusetts Avenue
Cambridge, MA 02139-4307
United States

HOME PAGE: http://https://sites.google.com/site/lawrencedwschmidt/home

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