Risk, Unemployment, and the Stock Market: A Rare-Event-Based Explanation of Labor Market Volatility
63 Pages Posted: 21 Sep 2015 Last revised: 1 Oct 2015
Date Written: September 2015
What is the driving force behind the cyclical behavior of unemployment and vacancies? What is the relation between job-creation incentives of firms and stock market valuations? We answer these questions in a model with time-varying risk, modeled as a small and variable probability of an economic disaster. A high probability implies greater risk and lower future growth, lowering the incentives of firms to invest in hiring. During periods of high risk, stock market valuations are low and unemployment rises. The model thus explains volatility in equity and labor markets, and the relation between the two.
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