Insurance and Opportunities: A Welfare Analysis of Labor Market Risk

Jonathan Heathcote, Kjetil Storesletten and Giovanni Violante

No 13673, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Using a model with constant relative risk-aversion preferences, endogenous labor supply and partial insurance against idiosyncratic wage risk, we provide an analytical characterization of three welfare effects: (a) the welfare effect of a rise in wage dispersion, (b) the welfare gain from completing markets, and (c) the welfare effect from eliminating risk. Our analysis reveals an important trade-off for these welfare calculations. On the one hand, higher wage uncertainty increases the cost associated with missing insurance markets. On the other hand, greater wage dispersion presents opportunities to raise aggregate productivity by concentrating market work among more productive workers. Our welfare effects can be expressed in terms of the underlying parameters defining preferences and wage risk, or alternatively in terms of changes in observable second moments of the joint distribution over individual wages, consumption and hours.

JEL-codes: E21 J22 J31 (search for similar items in EconPapers)
Date: 2007-12
New Economics Papers: this item is included in nep-bec, nep-dge, nep-ias, nep-lab, nep-mac and nep-upt
Note: EFG PE
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Published as Heathcote, Jonathan & Storesletten, Kjetil & Violante, Giovanni L., 2008. "Insurance and opportunities: A welfare analysis of labor market risk," Journal of Monetary Economics, Elsevier, vol. 55(3), pages 501-525, April.

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