Forecasted Unemployment and the Cross-Section of Stock Returns

Abstract

This paper provides evidence to the importance of revisions in expected unemployment rate in the cross-sectional pricing of individual stocks. We introduce a measure of unemployment beta which quantifies monthly-varying stock sensitivity to the innovations in forecasted unemployment rate. Stocks in the lowest unemployment beta decile generate 7% more annualized risk-adjusted return compared to stocks in the highest unemployment beta decile. The unemployment premium is higher during low economic activity, high economic uncertainty, and high unemployment periods. The premium is robust to various regression specifications which account for various risk factors, and macroeconomic and financial variables. Finally, (labor) operating leverage is an important factor in the cross-sectional pricing of unemployment beta.

Keywords: Unemployment, revisions in expected unemployment rate, return predictability, operating leverage

JEL Classification: G11, G12, E24, E44.