The School of Economics invites you to a HDR seminar presented by Tom Cusbert (University of Sydney).

Abstract

Over the past 30 years in the US, the labour share of income has fallen and the price-to-earnings ratio of the stock market has risen. Both facts run counter to most economic models, which imply these ratios should be stationary. This paper extends a standard consumption-CAPM to allow for persistent drifts in the labour share of income, and shows how this can lead to large changes in the equilibrium PE ratio. A calibrated simulation suggests the drift in the labour share of income over the past 30 years can account for a substantial fraction of the increase in the PE ratio over the same period.

This extended CCPAM can also explain an asset pricing puzzle: in standard models, higher expected aggregate asset returns lead to lower prices, which does not appear to hold empirically. In my extended model, higher asset return expectations that are not matched by higher labour income expectations can lead to increased prices. Higher expected returns make assets more attractive, but the (usually dominant) offsetting motive to bring forward consumption is attenuated by relatively low labour income expectations.