Labor Market Frictions and Asset Prices

The authors survey research on labor market frictions and their implications for asset pricing, adopting a firm-centric perspective. Starting from a neoclassical, frictionless labor model as the benchmark, they introduce labor adjustment costs and wage rigidity to examine how these frictions shape firm value, risk, and expected returns. Labor adjustment costs make a firm's installed labor force a quasi-fixed asset that directly contributes to valuation, while wage rigidity acts as operating leverage, amplifying profit volatility and raising required returns. The interaction between labor and financial frictions magnifies these effects, as labor commitments constrain financial flexibility and increase default risk. They then consider extensions incorporating labor heterogeneity, capital–skill complementarity, task automation, search-and-matching frictions, and imperfect risk-sharing between firms and workers. For each framework, they review the related theoretical mechanisms and supporting empirical evidence.