DP1353 Labour Contracts, Operating Leverage and Asset Pricing

Author(s): Jean-Pierre Danthine, John B Donaldson
Publication Date: February 1996
Keyword(s): Excess Volatility, Labour Contracts, Risk Premium
JEL(s): E32, G12
Programme Areas: International Macroeconomics, Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1353

This paper studies the pricing of financial assets in a complete general equilibrium set-up. We begin with an asset pricing model à la Lucas grafted on a standard Real Business Cycles model. We provide a new decentralized interpretation of such a model in which firms make meaningful investment decisions. We then confront qualitatively and quantitatively the implications of this model with financial observations. Drawing lessons from this exercise, we progressively enrich the model by introducing costs of adjusting the stock of capital, corporate debt and risk-sharing labour contracts. We find the latter to be particularly important in reconciling the model?s predictions with observations. We conclude that additional progress towards solving outstanding puzzles may come as much from a richer modelling of the real side of our economies as from further refinements in the description of the financial sector.