Insurance in Human Capital Models with Limited Enforcement

63 Pages Posted: 11 Jul 2016

See all articles by Tom Krebs

Tom Krebs

University of Mannheim

Moritz Kuhn

University of Bonn

Mark L. J. Wright

Federal Reserve Banks - Federal Reserve Bank of Minneapolis

Multiple version iconThere are 4 versions of this paper

Date Written: 2016-03-26

Abstract

This paper develops a tractable human capital model with limited enforceability of contracts. The model economy is populated by a large number of long-lived, risk-averse households with homothetic preferences who can invest in risk-free physical capital and risky human capital. 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). We provide a convenient equilibrium characterization that facilitates the computation of recursive equilibria substantially. We use a calibrated version of the model with stochastically aging households divided into 9 age groups. Younger households have higher expected human capital returns than older households. According to the baseline calibration, for young households less than half of human capital risk is insured and the welfare losses due to the lack of insurance range from 3 percent of lifetime consumption (age 40) to 7 percent of lifetime consumption (age 23). Realistic variations in the model parameters have non-negligible effects on equilibrium insurance and welfare, but the result that young households are severely underinsured is robust to such variations.

Keywords: Human capital, Household, Insurance, Risk, Limited Enforcement

JEL Classification: D52, E21, E24, J24

Suggested Citation

Krebs, Tom and Kuhn, Moritz and Wright, Mark L.J., Insurance in Human Capital Models with Limited Enforcement (2016-03-26). FRB of Chicago Working Paper No. WP-2016-8. Available at SSRN: https://ssrn.com/abstract=2807297

Tom Krebs (Contact Author)

University of Mannheim ( email )

Universitaetsbibliothek Mannheim
Zeitschriftenabteilung
Mannheim, 68131
Germany

Moritz Kuhn

University of Bonn ( email )

Regina-Pacis-Weg 3
Postfach 2220
Bonn, D-53012
Germany

Mark L.J. Wright

Federal Reserve Banks - Federal Reserve Bank of Minneapolis ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States

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