Frictional unemployment with stochastic bubbles

We show that the volatility puzzle in labor economics (Shimer, 2005) stems from the inability of technology shocks to generate sufficient volatility of firm value. We introduce non-fundamental shocks to firm value, akin to bubbles, into an otherwise standard search-and-matching model. When calibrated to stock market data, stochastic bubbles significantly improve the ability of the matching model to quantitatively explain the volatility of the US labor market. An extension with multiple sectors improves the persistence of simulated labor market variables.