Time-varying Risk Premium and Unemployment Risk Across Age Groups
Review of Financial Studies, Forthcoming
73 Pages Posted: 6 Mar 2018 Last revised: 21 Oct 2019
Date Written: July 15, 2019
We show that time-varying risk premium in financial markets can explain a key yet puzzling feature of labor markets: the large differences in unemployment risk across worker age-groups over the business cycle. Our search model features a time-varying risk premium and learning about unobserved heterogeneity in worker productivity. Their interaction generates large real effects through firms' labor policies. Our model predicts higher unemployment risk of younger workers relative to prime-age workers when risk premium is high, and the employment ratio of prime-age to young workers to be more cyclical in high beta industries. We find empirical support for these predictions.
Keywords: Time-varying risk premium, labor search, unemployment risk across age groups, labor market cleansing
JEL Classification: D83, E24, E32, E44, J11, J63, J64
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