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A Life-Cycle Model with Unemployment Traps

Fabio Bagliano (), Carolina Fugazza () and Giovanna Nicodano
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Carolina Fugazza: Department of Economics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino, Italy

No 41, Working papers from Department of Economics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino

Abstract: The Great Recession has highlighted that long-term unemployment may become a trap with loss of human capital. This paper extends the life-cycle model allowing for a small risk of long-term unemployment with permanent effects on labour income. Such nonlinear income risk dampens both early consumption and early investment in risky assets, resulting in an optimal equity portfolio share relatively flat in age. The driver of such flattening in the life-cycle profile is the resolution of uncertainty, as the worker ages, concerning this personal disaster. Shifting to such flatter investment profile away from a simple "age rule" delivers mean welfare gains that are three times larger than in models with linear labour income shocks.

Keywords: Disaster risk; Life-cycle portfolio choice; Unemployment risk; Human capital depreciation; Age rule. (search for similar items in EconPapers)
JEL-codes: D15 E21 G11 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge and nep-mac
Date: 2017-09
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http://www.bemservizi.unito.it/repec/tur/wpapnw/m41.pdf First version, 2017 (application/pdf)

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Working Paper: A Life-Cycle Model with Unemployment Traps (2019) Downloads
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