Labor Separations and Stock Returns

Description

This project seeks to understand the role of labor separations, i.e., worker quits and firm fires, played in shaping asset prices. It is typically overlooked in the labor-asset pricing literature. For aggregate level studies, e.g., Merz and Yashiv (2007) and Petrosky- Nadeau, Zhang and Kuehn (2018), they assume that the labor separation rate is constant. For firm level studies, e.g., Belo, Lin, and Bazdresch (2014) and Kuehn, Simutin, and Wang (2014), they assume that the quit rate is constant. But in reality, the labor separation rate is time-varying: the quit rate is procyclical and the firing rate is countercyclical. In this project, I am among the first to document the empirical relationships between separation rates, i.e., the quit rate and the firing rate, and stock returns by running predictive regressions. Because the equity risk premium is countercyclical, I hypothesize that the quit rate negatively predicts stock returns, while the firing rate positively predict stock returns. Then I will build a business cycle model with on-the-job search in the labor market to rationalize the empirical relationships, while allowing the model to jointly account for labor market dynamics and asset prices. Importantly, I will highlight how the workers’ quitting decisions are informative about risk premium, which complements the focus of previous literature on the firms’ hiring decisions. Intuitively, the workers’ quitting decisions, like the firms’ hiring decisions, are forward-looking and respond to shocks to discount rates. When discount rates decrease, the marginal benefit of searching for a higher-wage job will be higher. Workers will search more intensively and the quit rate today will be higher. Therefore, the quit rate will be negatively associated with future stock returns.