NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

An Equilibrium Asset Pricing Model with Labor Market Search

Lars-Alexander Kuehn, Nicolas Petrosky-Nadeau, Lu Zhang

NBER Working Paper No. 17742
Issued in January 2012
NBER Program(s):   AP   EFG   LS

Search frictions in the labor market help explain the equity premium in the financial market. We embed the Diamond-Mortensen-Pissarides search framework into a dynamic stochastic general equilibrium model with recursive preferences. The model produces a sizeable equity premium of 4.54% per annum with a low interest rate volatility of 1.34%. The equity premium is strongly countercyclical, and forecastable with labor market tightness, a pattern we confirm in the data. Intriguingly, search frictions, combined with a small labor surplus and large job destruction flows, give rise endogenously to rare disaster risks a la Rietz (1988) and Barro (2006).

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Document Object Identifier (DOI): 10.3386/w17742

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