Frictional Unemployment with Stochastic Bubbles

71 Pages Posted: 2 Oct 2016 Last revised: 13 Jun 2017

See all articles by Guillaume Vuillemey

Guillaume Vuillemey

HEC Paris - Finance Department

Etienne Wasmer

New York University (NYU) - New York University Abu Dhabi; Centre for Economic Policy Research (CEPR)

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Date Written: June 12, 2017

Abstract

Financial markets and labor markets are linked: aggregate employment and stock market indices co-move positively and their volatility is comparable. While existing search-and-matching models perfectly capture the relative magnitude of these volatilities (Pissarides' law), they fail in predicting their level (Shimer puzzle). We show that bubbles in a search-and-matching economy allow amplifying volatility in firm value and replicating the empirical volatility of unemployment. Firms switch randomly between a stationary state and a bubbly state in which firm value is explosive. The coordination on explosive solutions induces distortions in hiring decisions and wages, which we explicitly characterize. The specification significantly improves the quantitative ability of the model to match US data, along both real and financial dimensions.

Keywords: Unemployment Volatility, Labor Frictions, Bubbles

JEL Classification: E32, J60

Suggested Citation

Vuillemey, Guillaume and Wasmer, Etienne, Frictional Unemployment with Stochastic Bubbles (June 12, 2017). Available at SSRN: https://ssrn.com/abstract=2846302 or http://dx.doi.org/10.2139/ssrn.2846302

Guillaume Vuillemey (Contact Author)

HEC Paris - Finance Department ( email )

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Paris, Not Applicable 78351
France
+33660204275 (Phone)

HOME PAGE: http://sites.google.com/site/guillaumevuillemey/home

Etienne Wasmer

New York University (NYU) - New York University Abu Dhabi ( email )

PO Box 129188
Abu Dhabi
United Arab Emirates

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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