Portfolio Choices, Firm Shocks and Uninsurable Wage Risk

Andreas Fagereng, Luigi Guiso and Luigi Pistaferri

No 22883, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Assessing the importance of uninsurable wage risk for individual financial choices faces two challenges. First, the identification of the marginal effect requires a measure of at least one component of risk that cannot be diversified or avoided. Moreover, measures of uninsurable wage risk must vary over time to eliminate unobserved heterogeneity. Second, evaluating the economic significance of risk requires knowledge of the size of all the wage risk actually faced. Existing estimates are problematic because measures of wage risk fail to satisfy the ”non-avoidability” requirement. This creates a downward bias which is at the root of the small estimated effect of wage risk on portfolio choices. To tackle this problem we match panel data of workers and firms and use the variability in the profitability of the firm that is passed over to workers to obtain a measure of uninsurable risk. Using this measure to instrument total variability in individual earnings, we find that the marginal effect of uninsurable wage risk is much larger than estimates that ignore endogeneity. We bound the economic impact of risk and find that its overall effect is contained, not because its marginal effect is small but because its size is small. And the size of uninsurable wage risk is small because firms provide substantial wage insurance.

JEL-codes: D14 D91 G11 J3 (search for similar items in EconPapers)
Date: 2016-12
New Economics Papers: this item is included in nep-ias and nep-lma
Note: EFG LS
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Citations: View citations in EconPapers (4)

Published as The Review of Economic Studies, Volume 85, Issue 1, 1 January 2018, Pages 437–474

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Related works:
Journal Article: Portfolio Choices, Firm Shocks, and Uninsurable Wage Risk (2018)
Working Paper: Back to background risk? (2016)
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