Hui Guo

English

Research Papers in Economics

February 2007 NationalEconomicTrends
Views expressed do not necessarily reflect official positions of the Federal Reserve System.
A
ccording to the definition used in government statis-
tics, a person who is actively looking for a paying
job but is unable to find one is considered to be
unemployed. Some positive level of unemployment always
exists because (i) firms continually adjust the size of their
work force in response to changing business conditions and
(ii) it takes time for an unemployed worker to find a new job.
It is common to use the unemployment rate—the number
of unemployed workers divided by the total civilian labor
force—to gauge labor market conditions, and this measure
is closely watched by monetary policymakers as well as
financial market participants.
The unemployment rate usually rises during business
recessions and falls during business expansions; and many
economists, e.g., Lilien (1982), argue that sectoral shifts
account for a large portion of the cyclical variation in unem-
ployment.1 The underlying premise is as follows: When an
economy is hit by an adverse shock, e.g., a sharp increase
in crude oil prices, then production resources—including
labor—will move from more adversely affected sectors to
less adversely affected sectors. Because of the presence of
industry-specific skills and the time-consuming nature of
the job search, the process of transferring workers across
industries tends to be slow and involves spells of unemploy-
ment. Therefore, an increase in intersectoral shifts leads to
higher unemployment by increasing the amount of labor
reallocation.
Loungani, Rush, and Tave (1990) 
suggest that stock market dispersion is a
good proxy for the volume of intersectoral
shifts.2 Intuitively, because stock prices
are equal to expected discounted future
cash flows, when stock prices in a sector
go up (down), the sector is likely to expe-
rience increased (decreased) cash flows
and thus demand more (less) labor input
in the future. Consistent with Lilien’s
(1982) conjecture, Loungani, Rush, and
Tave document a significantly positive
relation between stock market dispersion
and the future unemployment rate using
data for the period 1926-87.
In the accompanying chart, I replicate Loungani, Rush,
and Tave’s main finding for the period 1964:Q1 to 2006:Q4.
The solid line is the log stock market dispersion, which is
measured by the value-weighted average realized variance
of idiosyncratic shocks to all common stocks included in the
CRSP (Center for Research in Security Prices) database; and
it is lagged by one year.3 The dashed line is the change in
the unemployment rate from its level one year ago. As
hypothesized, the two variables tend to move in the same
direction, with a correlation coefficient of 0.27. In particular,
stock market dispersion appears to provide a good explanation
for the movement of the labor market in the past few years.
After the spectacular run-up in the second half of 1990s, the
prices of information technology stocks collapsed in the year
2000. Such a dramatic intersectoral shift was evidenced by
a sharp increase in stock market dispersion; it was also fol-
lowed by a sharp increase in the unemployment rate. More  -
over, the unemployment rate fell at the end of the sample as
stock market dispersion eventually receded.
—Hui Guo
1 Lilien, David M. “Sectoral Shifts and Cyclical Unemployment.” Journal of
Political Economy, August 1982, 90(4), pp. 773-93.
2 Loungani, Prakash; Rush, Mark and Tave, William. “Stock Market Dispersion
and Unemployment.” Journal of Monetary Economics, June 1990, 25(3), 
pp. 367-88.
3 The idiosyncratic shock to a stock is the part of its return that is not explained
by asset pricing models.
research.stlouisfed.org
Stock Market Dispersion and Unemployment
–4
–2
0
2
4
1964:Q1 1970:Q1 1976:Q1 1982:Q1 1988:Q1 1994:Q1 2000:Q1 2006:Q1
–5
–4
–3
–2
–1
Change in Unemployment Rate
(dashed line)
Log Stock Market Dispersion
(solid line, 
lagged one year) 
Log Stock Market Dispersion vs. 
Year-Over-Year Change in the Unemployment Rate

Stock market dispersion and unemployment

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Stock market dispersion and unemployment

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