Income Insurance and the Equilibrium Term Structure of Equity
This paper documents that GDP, wages and dividends are co integrated but feature term structures of risk respectively flat, increasing and decreasing. Income insurance within the firm from shareholders to workers explains those term structures: distributional risk smooths wages and enhances the short run risk of dividends. A simple general equilibrium model, where labor rigidity affects dividend dynamics and the price of short run risk, reconciles standard asset pricing facts with the term structures of equity premium and volatility and those of macroeconomic variables, at odds in leading models. Income insurance also helps to explain dividend growth predictability, cross sectional value premia, counter cyclical Sharpe ratios, and interest rates term premia.