An Equilibrium Asset Pricing Model with Labor Market Search
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).
You may purchase this paper on-line in .pdf format from SSRN.com ($5) for electronic delivery.
Document Object Identifier (DOI): 10.3386/w17742
Users who downloaded this paper also downloaded these: