Asset Prices and Unemployment Fluctuations

Patrick Kehoe, Pierlauro Lopez, Virgiliu Midrigan and Elena Pastorino

No 591, Staff Report from Federal Reserve Bank of Minneapolis

Abstract: Recent critiques have demonstrated that existing attempts to account for the unemployment volatility puzzle of search models are inconsistent with the procylicality of the opportunity cost of employment, the cyclicality of wages, and the volatility of risk-free rates. We propose a model that is immune to these critiques and solves this puzzle by allowing for preferences that generate time-varying risk over the cycle, and so account for observed asset pricing fluctuations, and for human capital accumulation on the job, consistent with existing estimates of returns to labor market experience. Our model reproduces the observed fluctuations in unemployment because hiring a worker is a risky investment with long-duration surplus flows. Intuitively, since the price of risk in our model sharply increases in recessions as observed in the data, the benefit from creating new matches greatly drops, leading to a large decline in job vacancies and an increase in unemployment of the same magnitude as in the data.

Keywords: Unemployment volatility puzzle; Shimer puzzle; Search model; search and matching models; Diamond-Mortenson-Pissarides model (search for similar items in EconPapers)
JEL-codes: E0 E20 E24 E32 J60 J63 J64 (search for similar items in EconPapers)
Pages: 55
Date: 2020-01-08
New Economics Papers: this item is included in nep-dge, nep-lab and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Related works:
Working Paper: Asset Prices and Unemployment Fluctuations (2020)
Working Paper: Asset Prices and Unemployment Fluctuations (2019)
Working Paper: Asset Prices and Unemployment Fluctuations (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedmsr:87571

DOI: 10.21034/sr.591

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