Wage Rigidity: A Solution to Several Asset Pricing Puzzles

Jack Favilukis and Xiaoji Lin

Working Paper Series from Ohio State University, Charles A. Dice Center for Research in Financial Economics

Abstract: In standard models wages are too volatile and returns too smooth. We make wages sticky through infrequent resetting, resulting in both (i) smoother wages and (ii) volatile returns. Furthermore, the model produces other puzzling features of financial data: (iii) high Sharpe Ratios, (iv) low and smooth interest rates, (v) time-varying equity volatility and premium, and (vi) a value premium. In standard models, highly pro-cyclical and volatile wages are a hedge. The residual profit becomes unrealistically smooth, as do returns. Smoother wages act like operating leverage, making profits more risky. Bad times and unproductive firms are especially risky because committed wage payments are high relative to output.

JEL-codes: E21 E23 E32 E44 G12 (search for similar items in EconPapers)
Date: 2012-09
New Economics Papers: this item is included in nep-mac
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Citations: View citations in EconPapers (6)

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Working Paper: Wage Rigidity: A Solution to Several Asset Pricing Puzzles (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:ecl:ohidic:2012-16

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