Risky Business Cycles
We identify a shock that explains the bulk of fluctuations in equity risk premia, and show that the shock also explains a large fraction of the business-cycle comovements of output, consumption, employment, and investment. Recessions induced by the shock are associated with reallocation away from full-time permanent positions, towards part-time and flexible contract workers. A real model with labor market frictions and fluctuations in risk appetite can explain all of these facts, both qualitatively and quantitatively. The size of risk-driven fluctuations depends on the relationship between the riskiness and productivity of different stores of value: if safe savings vehicles have relatively low marginal products, then a flight to safety will drive a larger aggregate contraction.
We thank Ana Lariau, Dana Lawson, and seminar participants at The Ohio State University, the Federal Reserve Bank of Atlanta, Monash University, University of Padua, Aarhus University and the participants in the AEA Annual Meeting for helpful comments. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.