Under-Insurance in Human Capital Models with Limited Enforcement

Moritz Kuhn, Tom Krebs and Mark Wright

No 11612, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: This paper uses a macroeconomic model calibrated to U.S. data to show that limited contract enforcement leads to substantial under-insurance against human capital risk. The model economy is populated by a large number of risk-averse households who can invest in risk-free physical capital and risky human capital. Expected human capital returns are age-dependent and calibrated to match the observed life-cycle profile of median labor income. Households have access to a complete set of credit and insurance contracts, but their ability to use the available financial instruments is limited by the possibility of default (limited contract enforcement). According to the baseline calibration, young households are severely under-insured against human capital (labor income) risk and the welfare losses due to the lack of insurance are substantial. These results are robust to realistic variations in parameter values.

Keywords: Human capital risk; Limited enforcement; Insurance (search for similar items in EconPapers)
JEL-codes: D52 E21 E24 J24 (search for similar items in EconPapers)
Date: 2016-11
New Economics Papers: this item is included in nep-dge, nep-hrm, nep-ias and nep-mac
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Journal Article: Under-Insurance in Human Capital Models with Limited Enforcement (2017)
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