DP1353 Labour Contracts, Operating Leverage and Asset Pricing
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.