Labor Income Risk and Stock Returns: The Role of Horizon Effects

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See all articles by Esther Eiling

Esther Eiling

University of Amsterdam - Amsterdam Business School

Frank De Jong

Tilburg University - Department of Finance

Roger J. A. Laeven

University of Amsterdam - Department of Quantitative Economics (KE)

Rob C. Sperna Weiland

University of Amsterdam Business School; Tinbergen Institute

Date Written: April 9, 2019

Abstract

This paper shows that the impact of labor income risk on the cross-section of expected stock returns depends crucially on the horizon. Using a flexible empirical approach that allows us to include multiple horizons simultaneously, we find robust evidence that the two- to four-year horizon strongly dominates. Labor income risk at this medium term horizon carries a highly significant price of risk, while at other horizons it does not. A simple two-factor model that includes the equity market return and labor income risk at the medium term horizon can explain a striking 71% of the cross-sectional variation of 25 size book-to-market and 25 size-investment portfolios. This is a significant improvement over the standard human capital CAPM with quarterly labor income growth that has an R-squared of only 7%. Also, labor income risk generates significant adjustments to the composition of the optimal risky equity portfolio at the medium term horizon. These results are consistent with wage stickiness, where wages are reset every two to four years.

Keywords: Labor and Finance, Human Capital, Horizon Effects, Cross-Section of Stock Returns, Hedging Demand

JEL Classification: G11, G12, J24, C58

Suggested Citation

Eiling, Esther and De Jong, Frank and Laeven, Roger Jean Auguste and Sperna Weiland, Rob C., Labor Income Risk and Stock Returns: The Role of Horizon Effects (April 9, 2019). Available at SSRN: https://ssrn.com/abstract=

Esther Eiling

University of Amsterdam - Amsterdam Business School ( email )

Plantage Muidergracht 12
Amsterdam, 1018 TV
Netherlands

Frank De Jong

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Roger Jean Auguste Laeven

University of Amsterdam - Department of Quantitative Economics (KE) ( email )

Valckenierstraat 65-67
Amsterdam, 1018 XE
Netherlands
+31 20 525 4252 (Phone)

HOME PAGE: http://www.rogerlaeven.com

Rob C. Sperna Weiland (Contact Author)

University of Amsterdam Business School ( email )

Roetersstraat 18
Amsterdam, 1018WB
Netherlands

Tinbergen Institute ( email )

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

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