Carnegie Mellon University
Tepper School of Business
5000 Forbes Avenue
Pittsburgh, PA 15213
NBER Working Papers and Publications
|January 2012||An Equilibrium Asset Pricing Model with Labor Market Search|
with Nicolas Petrosky-Nadeau, Lu Zhang: w17742
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).