Frictional Wage Dispersion in Search Models: A Quantitative Assessment

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

See all articles by Andreas Hornstein

Andreas Hornstein

Federal Reserve Bank of Richmond

Per Krusell

Princeton University - Department of Economics; Stockholm University - Institute for International Economic Studies (IIES); Centre for Economic Policy Research (CEPR)

Giovanni L. Violante

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

Multiple version iconThere are 2 versions of this paper

Date Written: November 2007

Abstract

Standard search and matching models of equilibrium unemployment, once properly calibrated, can generate only a small amount of frictional wage dispersion, i.e., wage differentials among ex-ante similar workers induced purely by search frictions. We derive this result for a specific measure of wage dispersion -- the ratio between the average wage and the lowest (reservation) wage paid. We show that in a large class of search and matching models this statistic (the "mean-min ratio") can be obtained in closed form as a function of observable variables (i.e., the interest rate, the value of leisure, and statistics of labor market turnover). Various independent data sources suggest that actual residual wage dispersion (i.e., inequality among observationally similar workers) exceeds the model's prediction by a factor of 20. We discuss three extensions of the model (risk aversion, volatile wages during employment, and on-the-job search) and find that, in their simplest versions, they can improve its performance, but only modestly. We conclude that either frictions account for a tiny fraction of residual wage dispersion, or the standard model needs to be augmented to confront the data. In particular, the last generation of models with on-the-job search appears promising.

Suggested Citation

Hornstein, Andreas and Krusell, Per L. and Violante, Giovanni L., Frictional Wage Dispersion in Search Models: A Quantitative Assessment (November 2007). NBER Working Paper No. w13674. Available at SSRN: https://ssrn.com/abstract=1077094

Andreas Hornstein (Contact Author)

Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
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Per L. Krusell

Princeton University - Department of Economics ( email )

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HOME PAGE: http://rincewind.iies.su.se/%7Ekrusell/

Stockholm University - Institute for International Economic Studies (IIES) ( email )

Stockholm, SE-10691
Sweden
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HOME PAGE: http://rincewind.iies.su.se/%7Ekrusell/

Centre for Economic Policy Research (CEPR)

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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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