Risky Business Cycles

We identify a shock that explains the bulk of fluctuations in the equity risk premium, and show that the shock also explains a large fraction of the business-cycle comovements of output, consumption, employment, and investment. Recessions induced by the shock are associated with a reallocation away from full-time labor positions, and towards part-time and flexible contract workers. We explain the data using a novel real model with labor market frictions and fluctuations in risk appetite. Since safer factors of production have lower marginal products in equilibrium, a “flight-to-safety” from riskier to safer factors precipitates a macroeconomic recession.