Skip to main content

Asset Pricing with Endogenously Uninsurable Tail Risk

Staff Report 570 | Revised October 5, 2020

Download PDF

Authors

Hengjie Ai University of Minnesota

Asset Pricing with Endogenously Uninsurable Tail Risk

Abstract

This paper studies asset pricing and labor market dynamics when idiosyncratic risk to human capital is not fully insurable. Firms use long-term contracts to provide insurance to workers, but neither side can fully commit; furthermore, owing to costly and unobservable retention effort, worker-firm relationships have endogenous durations. Uninsured tail risk in labor earnings arises as a part of an optimal risk-sharing scheme. In equilibrium, exposure to the tail risk generates higher aggregate risk premia and higher return volatility. Consistent with data, firm-level labor share predicts both future returns and pass-throughs of firm-level shocks to labor compensation.