Asset Pricing Implications of Equilibrium Business Cycle Models : Operating Leverage Redux

Operating leverage, the observation that the share of capital is riskier than the share of labour due to the priority status of wage claims over the business cycles, has been believed to be relevant to a resolution of the equity premium puzzle. This paper asks whether asset pricing fluctuations induced by operating leverage are empirically plausible. We find that operating leverage generated by our Taylor-type staggered Nash wage bargaining in an equilibrium business cycle model with flows in and out of employment is relevant for justifying a sizable equity premium while it keeps the low volatility of risk-free rates intact. We also identify GHH preferences (Greenwood et al. (1988)) as a necessary ingredient in order for the proposed model to be appropriately calibrated on the macro side.