Risks to Human Capital
84 Pages Posted: 5 Sep 2019 Last revised: 7 Jul 2020
Date Written: July 5, 2020
Do financing constraints deepen recessions? To help answer this question, we build a model with inalienable human capital, in which investors finance individuals who can potentially become skilled. Though investment in skill is always optimal, it does not take place in some states of the world, due to moral hazard. In intermediate states of the world,
individuals acquire skill; however outside investors and individuals inefficiently share risk. We show that this simple moral hazard problem, combined with risk aversion of individuals and outside investors, leads to disaster states that fall especially heavily on some agents but not on others. The model implies a realistic equity premium and a low riskfree rate. We show that the possibility of disaster states distorts risk prices, even under calibrations in which they never occur in equilibrium.
Keywords: Financing Frictions, Rare Events, Moral Hazard
JEL Classification: G12, G32
Suggested Citation: Suggested Citation