Wage Rigidity: A Quantitative Solution to Several Asset Pricing Puzzles

Jack Favilukis, Xiaoji Lin

Research output: Contribution to journalArticlepeer-review

33 Scopus citations

Abstract

In standard production models, wage volatility is far too high, and equity volatility is far too low. A simple modification-sticky wages because of infrequent resetting together with a constant elasticity of substitution (CES) production function leads to both smoother wages and higher equity volatility. Further, the model produces several other hard-to-explain features of financial data: high Sharpe ratios, low and smooth interest rates, time-varying equity volatility and premium, a value premium, and a downward-sloping equity term structure. Procyclical, volatile wages are a hedge for firms in standard models; smoother wages act like operating leverage, making profits and dividends riskier.

Original languageEnglish (US)
Pages (from-to)148-192
Number of pages45
JournalReview of Financial Studies
Volume29
Issue number1
DOIs
StatePublished - Jan 1 2016
Externally publishedYes

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