Under-Insurance in Human Capital Models with Limited Enforcement

67 Pages Posted: 7 Nov 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

Date Written: November 2016

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, Insurance, Limited Enforcement

JEL Classification: D52, E21, E24, J24

Suggested Citation

Krebs, Tom and Kuhn, Moritz and Wright, Mark L.J., Under-Insurance in Human Capital Models with Limited Enforcement (November 2016). CEPR Discussion Paper No. DP11612. Available at SSRN: https://ssrn.com/abstract=2865882

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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