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Future Labor Income Growth and the Cross Section of Equity Returns

By Dongcheol Kim, Tong Suk Kim and Byoung-kyu Min


This paper examines the equilibrium relation between future labor income growth and expected asset returns; it proposes revisions in the expectation of future labor income growth as a macroeconomic state variable and suggests a three-factor model, including a factor related to this variable, along with the consumption growth factor and the market factor. The proposed future labor income growth factor is positively associated with the Fama-French factors and subsumes their explanatory power in explaining the cross section of stock returns. These results provide a possible economic explanation for the roles of the Fama-French factors: they are compensation for higher exposure to the risk related to changes in the value of human capital. This paper also compares the performance of the proposed three-factor model with other competing models and finds that the proposed model specification better captures cross-sectional variation in average returns than any of the competing asset pricing models considered. JEL classification: G12; G14

Topics: Future labor income growth, Fama-French factors, Economic tracking portfolio, Intertemporal CAPM
Year: 2010
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