Working Paper: NBER ID: w24972
Authors: Hengjie Ai; Anmol Bhandari
Abstract: This paper studies asset pricing and labor market dynamics in a setting in which idiosyncratic risk in human capital is not fully insurable. Firms use long-term contracts to provide insurance to workers, but neither side can fully commit; furthermore, owing to costly and unobservable retention effort, worker-firm relationships have endogenous durations. Uninsured tail risk in labor earnings arises as a part of an optimal risk-sharing scheme. In equilibrium, exposure to the tail risk generates higher aggregate risk premia and higher return volatility. Consistent with data, firm-level labor share predicts both future returns and pass-throughs of firm-level shocks to labor compensation.
Keywords: Asset Pricing; Labor Market Dynamics; Uninsurable Tail Risk
JEL Codes: E24; G12; J3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| uninsured tail risk in labor earnings (J79) | aggregate equity premiums (G12) |
| uninsured tail risk in labor earnings (J79) | stock market return volatility (G17) |
| anticipation of future lack of risk-sharing (D84) | current marginal utilities of workers (J29) |
| current marginal utilities of workers (J29) | share of aggregate output allocated to workers (D33) |
| share of aggregate output allocated to workers (D33) | labor share (D33) |
| firm-level labor share (J39) | future returns (G17) |
| firm-level shocks (D22) | labor compensation (J30) |
| agency frictions (D82) | separation risk after adverse productivity shocks (J63) |
| elevated separation risk (J62) | volatility of the stochastic discount factor (G17) |
| fraction of firms hitting limited commitment constraint (D22) | volatility of the stochastic discount factor (G17) |