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Federal Reserve Bank of San Francisco
Working Paper Series
Implications of Labor Market Frictions for Risk Aversion and Risk Premia
Eric T. Swanson
Abstract

A flexible labor margin allows households to absorb shocks to asset values with changes in hours worked as well as changes in consumption. This ability to absorb shocks along both margins can greatly alter the household’s attitudes toward risk, as shown in Swanson (2012). The present paper analyzes how frictional labor markets affect that analysis. Risk aversion is higher: 1) in recessions, 2) in countries with more frictional labor markets, and 3) for households that have more difficulty finding a job. These predictions are consistent with empirical evidence from a variety of sources. Traditional, fixed-labor measures of risk aversion show no stable relationship to the equity premium in a standard real business cycle model with search frictions, while the closed-form expressions derived in the present paper match the equity premium closely.


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Eric T. Swanson, Implications of Labor Market Frictions for Risk Aversion and Risk Premia, Federal Reserve Bank of San Francisco, Working Paper Series 2013-30, 2013, revised 03 Sep 2014.
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DOI: 10.24148/wp2013-30
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