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Future labor income growth and the cross-section of equity returns
Authors:Dongcheol Kim
Institution:a Business School, Korea University, Seoul, Republic of Korea
b Graduate School of Finance, Korea Advanced Institute of Science and Technology (KAIST), Seoul, Republic of Korea
c Fisher College of Business, Ohio State University, OH 43204, USA
Abstract: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.
Keywords:G12  G14
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