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Does Unemployment Risk Affect Asset Returns? The Long-Run UK Evidence

This paper examines the correlation structure between asset returns and unemployment surprises. Using UK data, it is possible to study this relationship not only over the more economically stable post WWII period, but also during the Great Depression. It is shown that the correlation between stock returns and unemployment shocks is significantly negative during the inter-war years, but not in the period since WWII. This is consistent with theoretical work that suggests that labor income risk concentrated in economic "crash" states is most likely to resolve the equity premium puzzle.