Labor market dynamics, endogenous growth, and asset prices

- We introduce endogenous labor decisions into the Kung and Schmid (2015) economy.
- Moreover, two variants of wage rigidities are added.
- Pro-cyclical labor generates a rise in the equity risk premium of 250 basis points.
- Wage rigidities produce sufficiently volatile labor hours and smooth wages.

We extend the endogenous growth model of Kung and Schmid (2015) by adding endogenous labor dynamics and two variants of wage rigidities. This leads to an increase of 250-350 basis points in the risk premia, depending on the model specification. Additionally, it brings labor market quantities much closer to their empirical counterparts. In particular, wage rigidities generate an increase of around 60-250 basis points in labor growth volatility, which depends on how wage rigidities are modeled.