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Asset Pricing with Endogenously Uninsurable Tail Risk

Hengjie Ai and Anmol Bhandari
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Hengjie Ai: University of Minnesota
Anmol Bhandari: Federal Reserve Bank of Minneapolis

No 570, Staff Report from Federal Reserve Bank of Minneapolis

Abstract: This paper studies asset pricing in a setting in which idiosyncratic risk in human capital is not fully insurable. Firms use long-term contracts to provide insurance to workers, but neither side can commit to these contracts; furthermore, worker-firm relationships have endogenous durations owing to costly and unobservable effort. Uninsured tail risk in labor earnings arises as a part of an optimal risk-sharing scheme. In the general equilibrium, exposure to the resulting tail risk generates higher risk premia, more volatile returns, and variations in expected returns across firms. Model outcomes are consistent with the cyclicality of factor shares in the aggregate, and the heterogeneity in exposures to idiosyncratic and aggregate shocks in the cross section.

Keywords: Equity premium puzzle; Dynamic contracting; Tail risk; Limited commitment (search for similar items in EconPapers)
JEL-codes: E3 G1 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-ias and nep-mac
Date: 2018-08-22
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DOI: 10.21034/sr.570

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