Abstract:
Labor income risk displays strong horizon effects. We show that a shock in stock returns is reflected in aggregate wages with a delay of two to four years. This medium–run horizon is consistent with wage rigidity and has significant implications for asset pricing. We find that medium–run aggregate labor income risk is a robustly priced macro risk factor. In contrast, short– and long–run labor income risk are not priced. The effect of a simple horizon adjustment is strong: the cross–sectional R2 for 50 size, book–to–market and investment sorted portfolios increases from 5% to 64% when going from quarterly labor income growth to medium–run labor income growth as the risk factor. Labor income risk is nearly uncorrelated with consumption risk when measured over the same medium–term horizon. Our empirical specification follows directly from a stylized labor asset pricing model in which investors have different career lengths over which they earn labor income, leading to horizon– specific prices of labor income risk.