TY - JOUR
T1 - Asset Prices and Unemployment Fluctuations
T2 - A Resolution of the Unemployment Volatility Puzzle
AU - Kehoe, Patrick J.
AU - Lopez, Pierlauro
AU - Midrigan, Virgiliu
AU - Pastorino, Elena
N1 - Publisher Copyright:
© 2022 The Author(s).
PY - 2023/5/1
Y1 - 2023/5/1
N2 - Recent work has demonstrated that existing solutions of the unemployment volatility puzzle are at odds with the procylicality of the opportunity cost of employment, the cyclicality of wages, and the volatility of risk-free rates. We propose a model of business cycles that is immune to these critiques by incorporating two key features. First, we allow for preferences that generate time-varying risk over the business cycle to account for observed fluctuations in asset prices. Second, we introduce human capital acquisition, as is consistent with the evidence on how wages grow with experience in the labor market. Our model reproduces the observed fluctuations in unemployment because hiring a worker is a risky investment with long-duration returns. As in the data, the price of risk in our model sharply increases in recessions. The benefit from hiring new workers therefore greatly declines, leading to a large decrease in job vacancies and an increase in unemployment of the same magnitude as in the data. We show that our results extend to versions of the model that include physical capital, a life cycle for workers, and alternative preference structures common in the asset-pricing literature.
AB - Recent work has demonstrated that existing solutions of the unemployment volatility puzzle are at odds with the procylicality of the opportunity cost of employment, the cyclicality of wages, and the volatility of risk-free rates. We propose a model of business cycles that is immune to these critiques by incorporating two key features. First, we allow for preferences that generate time-varying risk over the business cycle to account for observed fluctuations in asset prices. Second, we introduce human capital acquisition, as is consistent with the evidence on how wages grow with experience in the labor market. Our model reproduces the observed fluctuations in unemployment because hiring a worker is a risky investment with long-duration returns. As in the data, the price of risk in our model sharply increases in recessions. The benefit from hiring new workers therefore greatly declines, leading to a large decrease in job vacancies and an increase in unemployment of the same magnitude as in the data. We show that our results extend to versions of the model that include physical capital, a life cycle for workers, and alternative preference structures common in the asset-pricing literature.
KW - Business Cycles
KW - Human Capital
KW - Search and Matching
KW - Shimer Puzzle
KW - Stochastic Discount Factor
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U2 - 10.1093/restud/rdac048
DO - 10.1093/restud/rdac048
M3 - Article
AN - SCOPUS:85171522333
SN - 0034-6527
VL - 90
SP - 1304
EP - 1357
JO - Review of Economic Studies
JF - Review of Economic Studies
IS - 3
ER -