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FUTURE LABOR INCOME RISK, MULTIFACTOR ASSET PRICING, AND THE CROSS-SECTION OF EQUITY RETURNS: A COMPREHENSIVE REASSESSMENT
Issue Vol. 2 No. 2 (2025): Volume 2 Issue 2 --- Section Articles
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Abstract
Understanding the determinants of the cross-section of equity returns remains one of the most persistent and intellectually challenging problems in modern financial economics. Over several decades, researchers have proposed a wide range of theoretical explanations and empirical models to account for systematic variations in expected stock returns across firms, industries, and markets. Traditional single-factor models, most notably the Capital Asset Pricing Model, were gradually supplemented and challenged by multifactor frameworks such as the Fama–French models, behavioral explanations rooted in investor psychology, and conditional asset pricing approaches that allow risk premia to vary over time. More recently, labor income risk and human capital considerations have emerged as a crucial yet underexplored dimension in explaining asset prices. This article develops a comprehensive and integrative examination of future labor income growth as a state variable shaping equity returns, embedding this perspective within the broader literature on size, value, momentum, beta, and macroeconomic risk factors. Anchored in prior theoretical and empirical contributions, the study critically reassesses how labor income dynamics interact with established asset pricing factors to influence expected returns. The analysis emphasizes conceptual rigor rather than mathematical formalism, offering an extensive descriptive methodology and interpretive discussion that situates labor income risk within both classical and contemporary debates. By synthesizing insights from multifactor models, conditional asset pricing, and behavioral finance, the article argues that labor income growth expectations provide a unifying lens through which many observed anomalies in the cross-section of returns can be better understood. The findings contribute to ongoing discussions regarding model completeness, economic interpretation of factors, and the evolving role of macro-labor linkages in financial markets, while also outlining limitations and promising avenues for future research.
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References
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