Climbing and falling off the ladder: Asset pricing implications of labor market event risk

Lawrence D.W. Schmidt

Journal of Financial Economics, 2025, vol. 172, issue C

Abstract: Administrative earnings data reveal that households are exposed to large, countercyclical idiosyncratic tail risks in labor earnings. I illustrate how these risks affect asset prices within an asset pricing framework with recursive preferences, heterogeneous agents and incomplete markets. Quantitatively, a model in which agents face a time-varying probability of experiencing a rare, idiosyncratic disaster, with parameters disciplined by data, matches the level and dynamics of the equity premium. Stock returns are highly informative about labor market event risk, and, consistent with model predictions, initial claims for unemployment, a proxy for labor market uncertainty, is a highly robust predictor of returns.

Keywords: Asset pricing; Incomplete markets; State-dependent earnings risk; Return predictability; Equity risk premium (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:172:y:2025:i:c:s0304405x25001394

DOI: 10.1016/j.jfineco.2025.104131

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