Insurance and Opportunities: A Welfare Analysis of Labor Market Risk

50 Pages Posted: 19 Dec 2007 Last revised: 11 Feb 2008

See all articles by Jonathan Heathcote

Jonathan Heathcote

Minneapolis Fed

Kjetil Storesletten

University of Oslo - Department of Economics; Centre for Economic Policy Research (CEPR)

Giovanni L. Violante

New York University, Department of Economics; Centre for Economic Policy Research (CEPR)

Date Written: December 2007

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.

Suggested Citation

Heathcote, Jonathan and Storesletten, Kjetil and Violante, Giovanni L., Insurance and Opportunities: A Welfare Analysis of Labor Market Risk (December 2007). NBER Working Paper No. w13673. Available at SSRN: https://ssrn.com/abstract=1073653

Jonathan Heathcote (Contact Author)

Minneapolis Fed ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States

HOME PAGE: http://www.jonathanheathcote.com

Kjetil Storesletten

University of Oslo - Department of Economics ( email )

P.O. Box 1095 Blindern
N-0317 Oslo
Norway
+47 2284 4009 (Phone)
+47 2285 5035 (Fax)

HOME PAGE: http://folk.uio.no/kjstore/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Giovanni L. Violante

New York University, Department of Economics ( email )

269 Mercer Street
New York, NY 10003
United States
212-992-9771 (Phone)
212-995-4186 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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