Self-insurance in Turbulent Labor Markets

Abstract:

We investigate the effects of turbulence risk—the risk of persistent skill loss coinciding with involuntary layoffs—on individual and aggregate labor market outcomes. We build a dynamic heterogeneous agents model with directed search, imperfect financial markets, and uninsurable persistent labor market risk. We calibrate our model to the US economy, matching new empirical facts on the joint impact of turbulence risk and liquid wealth on re-employment wages, occupational choice, and unemployment duration. The model generates three self-insurance strategies: precautionary savings, precautionary job search, and precautionary occupational mobility. We quantify the role of these self-insurance mechanisms in coping with turbulence risk and assess the welfare gains from alternative government policies.