Income Insurance and the Equilibrium Term Structure of Equity

Abstract

ABSTRACTOutput, wages, and dividends feature term structures of variance ratios that are respectively flat, increasing, and decreasing. Income insurance from shareholders to workers explains these term structures. Risk‐sharing smooths wages but only concerns transitory risk and hence enhances short‐run dividend risk. As a result, actual labor‐share variation largely forecasts the risk, premium, and slope of dividend strips. A simple general equilibrium model in which labor rigidity affects dividend dynamics and the price of short‐run risk reconciles standard asset pricing facts with the term structures of the equity premium, volatility, and macroeconomic variables, which are at odds in leading models.