Working Paper: NBER ID: w28001
Abstract: Labor market frictions are crucial for the equity premium in production economies. A dynamic stochastic general equilibrium model with recursive utility, search frictions, and capital accumulation yields a high equity premium of 4.26% per annum, a stock market volatility of 11.8%, and a low average interest rate of 1.59%, while simultaneously retaining plausible business cycle dynamics. The equity premium and stock market volatility are strongly countercyclical, while the interest rate and consumption growth are largely unpredictable. Because of wage inertia, dividends are procyclical despite consumption smoothing via capital investment. The welfare cost of business cycles is huge, 29%.
Keywords: No keywords provided
JEL Codes: E32; E44; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Labor market frictions (wage inertia) (J29) | Equity premium (G19) |
| Profits (D33) | Equity premium (G19) |
| Wage inertia (J31) | Profits (D33) |
| Business cycles (E32) | Welfare cost (D69) |
| Cyclical nature of the economy (E32) | Welfare cost (D69) |