Wage Growth and Equity Risk Premia

52 Pages Posted: 17 Dec 2018 Last revised: 16 Mar 2019

See all articles by Paulo F. Maio

Paulo F. Maio

Hanken School of Economics - Department of Finance and Statistics

Byoung-Kyu Min

University of Sydney Business School; Financial Research Network (FIRN)

Multiple version iconThere are 2 versions of this paper

Date Written: March 14, 2019


We develop a simple three-factor consumption-based asset pricing model that includes wage growth as a risk factor, and evaluate whether the model explains six major CAPM anomalies: book-to-market, investment, operating profitability, long-term return reversal, net share issues, and residual variance. Wage growth arises in the pricing kernel by using a non-separable utility over consumption and leisure, and represents the growth in the opportunity cost of enjoying leisure hours. In the model, wage growth earns a negative price of risk, that is, higher wage growth leads to a decline in leisure demand, which increases the marginal utility of consumption for an investor with risk aversion above one. The empirical cross-sectional tests show that the model explains around 50% of the cross-sectional dispersion in average returns of the joint six CAPM anomalies (160 equity portfolios). Further, the proposed model compares favorably with alternative return-based multifactor models widely used in the literature. The risk price estimates for wage growth are significantly negative, while the implied preference parameter (share of leisure) estimates are economically plausible in most cases. Overall, our results suggest that aggregate wage growth can help explaining cross-sectional equity risk premia.

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

JEL Classification: E21, E44, G11, G12

Suggested Citation

Maio, Paulo F. and Min, Byoung-Kyu, Wage Growth and Equity Risk Premia (March 14, 2019). Available at SSRN: https://ssrn.com/abstract=3301818 or http://dx.doi.org/10.2139/ssrn.3301818

Paulo F. Maio

Hanken School of Economics - Department of Finance and Statistics ( email )

FI-00101 Helsinki

HOME PAGE: http://sites.google.com/site/paulofmaio/home

Byoung-Kyu Min (Contact Author)

University of Sydney Business School ( email )

Room 410 Codrington Building
The University of Sydney, NSW 2006
+61 2 9036 6356 (Phone)
+61 2 9351 6461 (Fax)

HOME PAGE: http://minbq.com/

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane

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