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Asset Pricing with Endogenously Uninsurable Tail Risks

Author

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  • anmol bhandari

    (university of minnesota)

  • Hengjie Ai

    (University of Minnesota)

Abstract

This paper studies asset pricing implications of idiosyncratic risk in labor productivities in a model where markets are endogenously incomplete. Well-diversified owners of firms provide insurance to workers using long-term wage contracts but cannot commit to ventures that yield a net present value of dividends. We show that under the optimal contract subject to limited commitment, workers are uninsured against tail risks in idiosyncratic productivities. Risk compensations are higher when we calibrate the model to replicate the feature that tail risk in labor income is more pervasive in recessions relative to expansions. Besides salient features of equity and bond markets, the model is consistent with other empirical facts such as the cyclicality of factor shares and limited stock market participation.

Suggested Citation

  • anmol bhandari & Hengjie Ai, 2016. "Asset Pricing with Endogenously Uninsurable Tail Risks," 2016 Meeting Papers 1523, Society for Economic Dynamics.
    • Handle: RePEc:red:sed016:1523
    as

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    References listed on IDEAS

    as
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    7. Herskovic, Bernard & Kelly, Bryan & Lustig, Hanno & Van Nieuwerburgh, Stijn, 2016. "The common factor in idiosyncratic volatility: Quantitative asset pricing implications," Journal of Financial Economics, Elsevier, vol. 119(2), pages 249-283.
    8. Jonathan Thomas & Tim Worrall, 1988. "Self-Enforcing Wage Contracts," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 55(4), pages 541-554.
    9. Fernando Alvarez & Urban J. Jermann, 2000. "Efficiency, Equilibrium, and Asset Pricing with Risk of Default," Econometrica, Econometric Society, vol. 68(4), pages 775-798, July.
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    11. repec:bla:jfinan:v:59:y:2004:i:4:p:1481-1509 is not listed on IDEAS
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    Cited by:

    1. Roberto Marfè, 2015. "Labor Rigidity and the Dynamics of the Value Premium," Carlo Alberto Notebooks 429, Collegio Carlo Alberto.

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