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American Economic Review: Vol. 101 No. 6 (October 2011)

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Aggregate and Idiosyncratic Risk in a Frictional Labor Market

Article Citation

Rudanko, Leena. 2011. "Aggregate and Idiosyncratic Risk in a Frictional Labor Market." American Economic Review, 101(6): 2823-43.

DOI: 10.1257/aer.101.6.2823

Abstract

This paper develops a tractable extension of a Mortensen-Pissarides style matching model that allows for risk averse workers with limited ability to smooth consumption. I show that this leads to a form of equilibrium wage rigidity, as the inability of workers to smooth their consumption across unemployment and employment spells changes how unemployed workers value wage offers, and hence also the offers that employers find profitable to make. In the model risk-averse entrepreneurs use optimal long-term contracts to attract risk averse workers facing limited access to asset markets. A simple analytic representation for the equilibrium is derived. (JEL D81, E21, E24, E32, J31, J41, J64)

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Authors

Rudanko, Leena (Boston U)

JEL Classifications

D81: Criteria for Decision-Making under Risk and Uncertainty
E21: Macroeconomics: Consumption; Saving; Wealth
E24: Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital
E32: Business Fluctuations; Cycles
J31: Wage Level and Structure; Wage Differentials
J41: Labor Contracts
J64: Unemployment: Models, Duration, Incidence, and Job Search


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