Income Insurance and the Equilibrium Term Structure of Equity

Abstract

This paper documents that GDP, wages and dividends are co-integrated but feature term-structures of risk respectively flat, increasing and decreasing. Income insurance within the firm from shareholders to workers explains those term-structures: distributional risk smooths wages and enhances the short-run risk of dividends. A simple general equilibrium model, where labor rigidity a ects dividend dynamics and the price of short-run risk, reconciles standard asset pricing facts with the term-structures of equity premium and volatility and those of macroeconomic variables, at odds in leading models.Income insurance also helps to explain dividend growth predictability, cross-sectional value premia, counter-cyclical Sharpe-ratios, and interest rates term-premia.Keywords. term structure of equity • income insurance • dividend strips • distributional risk • equilibrium asset pricing JEL Classification. D53 • E24 • E32 • G12 * An earlier version of this paper was circulated under the title "Labor Relations, Endogenous Dividends and the Equilibrium Term Structure of Equity." I would like to thank my supervisor Michael Rockinger and the members of my Ph.D. committee (Swiss Finance Institute) Philippe Bacchetta, Pierre Collin-Dufresne, Bernard Dumas and Lukas Schmid for stimulating conversations and many insightful comments and advices. I would also like to acknowledge comments from Michela Altieri,

Income Hedging, Dynamic Style Preferences, and Return Predictability

“…Our work also complements recent literature on how firms insure workers through their labor contracts, which can affect asset prices (Berk and Walden (), Marfè ()). We complement this work and argue that both hedging via labor contracts and financial markets can coexist.…”

“…We use the 10‐year window to be consistent with the recent macro‐finance literature. For example, Marfè () uses 10‐year rolling windows and quarterly data to calculate a time series of variance ratios in asset pricing tests…”

“…The estimation period is from Q1 1985 to Q4 2011. In column (7), the dependent variable is aggregate HML and we include the labor share of Marfè (2017) as an additional control. In column (7), the estimation period is from Q1 1970 to Q4 2011. t-statistics are reported below coefficient estimates.…”

“…We find that our results hold in both subsamples. In our second test, we compute the labor share measure of Marfè () and include it as an additional control variable in our national‐level HML predictive regressions. We find that IHD remains an economically and statistically significant HML predictor in the presence of the labor share measure.…”

Capital Share Risk in U.S. Asset Pricing

“…A growing body of literature considers the role of redistributive shocks that transfer resources between shareholders and workers as a source of priced risk when risk‐sharing is imperfect (Danthine and Donaldson (), Favilukis and Lin (2013, , ), Gomez (), GLL, Marfe ()). In this literature, labor compensation is a charge to claimants on the firm and therefore a systematic risk factor for aggregate stock and bond markets.…”