Asset Prices and Unemployment Fluctuations

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.

Why Does the Fed Move Markets so Much? A Model of Monetary Policy and Time-Varying Risk Aversion

“…In practice, this might capture that after an adverse shock consumers shift from eating out to cooking at home, as documented in Aguiar, Hurst, and Karabarbounis (2013). The assumption that home production increases with aggregate productivity, A t N t , ensures that the labor-leisure trade-off does not become irrelevant over time (Kehoe, Lopez, Midrigan, and Pastorino (2019)), consistent with empirical evidence (Chodorow-Reich and Karabarbounis (2016)). We then proceed with standard log-linearization of the firms' price-setting problem around the random walk component v * t (Cogley and Sbordone (2008)) to obtain the log-linearized Phillips curve:…”

Why Has the US Economy Recovered So Consistently from Every Recession in the Past 70 Years?

“…Attention has turned in the DMP literature to financial factors as driving forces for unemployment (Hall (2017), Kilic and Wachter (2018), Kehoe, Lopez, Midrigan and Pastorino (2020)). These papers observe that P − W is the discounted value of the future cash flow to the employer, along with other discounted flows in more elaborate models, and thus are sensitive to fluctuations in discount rates.…”

“…For example, a recent literature has described a relation between financial discounts and unemployment. See Hall (2017) in the context of the aggregate labor market and Kilic and Wachter (2018) and Kehoe et al (2020) in general equilibrium. These papers consider DMP-type models of unemployment and events that alter economy-wide discount rates, thus changing the job-value, which is the present value of the contribution of a newly hired worker net of the wage paid to the worker.…”

Average crossing time: An alternative characterization of mean aversion and reversion

“…6.4.2 Baseline model: Random walk technology shock Similar explorations can be proposed for the baseline model when its TFP process has the form {eλ t }, with {λ t } following (25). See also Swanson (2019) and Kehoe et al (2019). With the baseline model, the form of the decision rules, Eqs.…”