High Discounts and Low Fundamental Surplus: An Equivalence Result for Unemployment Fluctuations

Abstract

We establish an observational equivalence between unemployment fluctuations of
the Diamond-Mortensen-Pissarides search economy augmented with time-varying risk premia, and an otherwise identical economy without risk-premia but with a time-varying value of leisure. This equivalence holds for general risk-premia processes and allows us to view the effects of different models of risk-premia as operating through a single channel—one that alters the value of leisure. We derive simple expressions for semi-elasticities of labor market tightness with respect to productivity and risk premium shocks. We show wages can be used to detect misspecification in the discount rate process used in hiring decisions.

Keywords: Equivalence result, fundamental surplus, unemployment fluctuations, time-varying risk premia, heterogeneity, misspecification.

JEL Classification: E24, E32, E44, G10, J23, J63