Leisure, Labor Income, and Equity Risk Premia

Abstract

We derive a simple three-factor consumption-based asset pricing model, which includes wage growth as a risk factor (CW-CAPM). Wage growth earns a negative price of risk---a higher wage leads to a decline in leisure demand and a rise in the marginal utility of consumption. CW-CAPM (and a restricted version based on CRRA utility) explains around 55% of the joint cross-sectional dispersion in risk premia associated with 15 major CAPM anomalies. The wage growth risk price estimates are significantly negative, while the implied preference parameter (leisure share) estimates are economically plausible. The model compares favorably with alternative popular multifactor models.

Keywords: Asset pricing; Consumption-based asset pricing model; Macro asset pricing models; Leisure; Wage growth; Cross-section of stock returns; Stock market anomalies

JEL Classification: E21, E44, G11, G12