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on Utility Models and Prospect Theory |
| By: | Iñigo Iturbe-Ormaetxe; Giovanni Ponti; Josefa Tomás |
| Abstract: | Gneezy and Potters (1997) run an experiment to test the empirical content of Myopic Loss Aversion (MLA). They find that the attractiveness of a risky asset depends upon the investors’ time horizon: consistently with MLA, individuals are more willing to take risks when they evaluate their investments less frequently. This paper shows that these experimental findings can be easily accommodated by the most standard version of Expected Utility Theory, namely a CRRA specification. Additionally, we use four different datasets to estimate a CRRA model and two alternative MLA versions, together with various mixture specifications of the two competing models. Our econometric exercise finds little evidence of subjects’ loss aversion, which provides empirical ground for our theoretical claim. |
| Keywords: | Expected Utility Theory, Myopic Loss Aversion, Evaluation Period |
| JEL: | C91 D81 D14 |
| URL: | http://d.repec.org/n?u=RePEc:lui:cesare:1506&r=upt |
| By: | Lingqi Gu; Yiqing Lin; Junjian Yang |
| Abstract: | In this note, we study the utility maximization problem on the terminal wealth under proportional transaction costs and bounded random endowment. In particular, we restrict ourselves to the num\'eraire-based model and work with utility functions only supporting R+. Under the assumption of existence of consistent price systems and natural regularity conditions, standard convex duality results are established. Precisely, we first enlarge the dual domain from the collection of martingale densities associated with consistent price systems to a set of finitely additive measures; then the dual formulation of the utility maximization problem can be regarded as an extension of the paper of Cvitani\'c-Schachermayer-Wang (2001) to the context under proportional transaction costs. |
| Date: | 2016–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1602.01070&r=upt |
| By: | Kellner, Christian; Reinstein, David; Riener, Gerhard; Sanders, Michael |
| Abstract: | When and how should a fundraiser ask for a donation from an individual facing an uncertain bonus income? A standard model of expected utility over outcomes predicts that the individual’s before choice – her ex-ante commitment conditional on her income – will be the same as her choice after the income has been revealed. Deciding “if you win, how much will you donate?†involves a commitment (i) over a donation for a state of the world that may not be realized and (ii) over uncertain income. Models involving reference-dependent utility, tangibility, and self-signaling predict more giving before, while theories of affect predict more giving after. In our online field experiment at a UK university, as well as in our laboratory experiments in Germany, charitable giving was significantly larger in the Before treatment than in the After treatment for male subjects, with a significant gender differential. Lab treatments isolated distinct mechanisms: for men, donations were higher in all treatments where the donation’s collection was uncertain, whether or not the income was known. This supports a (self)-signaling explanation: commitments realized with a lower probability must involve larger amounts to have the same signaling power. Our results are directly relevant to fundraising and volunteer-recruitment strategies,and offer further evidence that we need to exercise caution in applying expected-utility theory in the presence of social preferences. |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:esx:essedp:13794&r=upt |
| By: | Sudhir A. Shah (Centre for Development Economics, Delhi School of Economics, University of Delhi, India) |
| Abstract: | One lottery over a vector outcome space is said to be riskier than another if every risk averse decision-maker weakly prefers the latter to the former. For very general vector outcome settings, we characterize this condition in terms of second order stochastic dominance applied to the families of utility distributions generated by the given lotteries and the admissible family of utility functions. The riskiness of random processes can be compared in this framework by identifying the risk- iness of a process with the riskiness of the distribution generated by it on the vector space containing its sample paths. We illustrate the characterization's usefulness by applying it to the analysis of auctions, utility regulation, inventory control, portfolio choice, public goods and moral hazard in teams. |
| Date: | 2016–01 |
| URL: | http://d.repec.org/n?u=RePEc:cde:cdewps:252&r=upt |
| By: | Lingqi Gu; Yiqing Lin; Junjian Yang |
| Abstract: | In this paper, we consider a num\'eraire-based utility maximization problem under proportional transaction costs and random endowment. Assuming that the agent cannot short sell assets and is endowed with a strictly positive contingent claim, a primal optimizer of this utility maximization problem exists. Moreover, we observe that the original market with transaction costs can be replaced by a frictionless shadow market that yields the same optimality. On the other hand, we present an example to show that in some case when these constraints are relaxed, the existence of shadow prices is still warranted. |
| Date: | 2016–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1602.01109&r=upt |
| By: | Giovanni Ponti; Ismael Rodriguez-Lara; Daniela Di Cagno |
| Abstract: | We report experimental evidence on the e§ects of social preferences on intertemporal decisions. To this aim, we set up an intertemporal Dictator Game and investigate whether (and how) subjects change their choices, compared with those they had taken in absence of any payo§ externality in a previous stage of the experiment. We run two treatments -INFO and BELIEF, respectively- depending on whether Dictators know -or are asked to elicit- their assigned Recipients' risk and time preferences. We find that high (own) risk aversion is associated with low (own) discounting. We also Önd that (heterogeneous) social time preferences are signifcant determinants of choices, in that Dictators display a marked propensity to account for the Recipients' intertemporal concerns. |
| Keywords: | intertemporal decisions, time preferences, social preferences |
| JEL: | C91 D70 D81 D91 |
| URL: | http://d.repec.org/n?u=RePEc:lui:cesare:1401&r=upt |
| By: | Daniel Gutknecht (Mannheim University); Stefan Hoderlein (Boston College); Michael Peters (Yale University) |
| Abstract: | Do individuals use all information at their disposal when forming expectations about future events? In this paper we present an econometric framework to answer this question. We show how individual information sets can be characterized by simple nonparametric exclusion restrictions and provide a quantile based test for constrained information processing. In particular, our methodology does not require individuals’ expectations to be rational, and we explicitly allow for individuals to have access to sources of information which the econometrician cannot observe. As an application, we use microdata on individual income expectations to study which information agents employ when forecasting future earnings. Consistent with models where information processing is limited, we find that individuals’ information sets are coarse in that valuable information is discarded. We then quantify the utility costs of coarse information within a standard consumption life-cycle model. Consumers would be willing to pay 0.04% of their permanent income to incorporate the econometrician’s information set in their forecasts. |
| Date: | 2016–02–01 |
| URL: | http://d.repec.org/n?u=RePEc:boc:bocoec:898&r=upt |
| By: | Gall, Thomas; Reinstein, David |
| Abstract: | When Al makes an offer to Betty that Betty observes and rejects, Al may “lose faceâ€. This loss of face (LoF) may cost Al utility, either directly or through reputation effects. This can lead to fewer offers and inefficiency in the context of bilateral matching problems, e.g., the marriage market, research partnering, and international negotiations. We offer a simple model with asymmetric information, a continuous signal of an individual’s binary type, and a linear marriage production function. We add a primitive LoF term, characterize the stable equilibria, compare the benchmark without LoF to a case where only one side is vulnerable to LoF, and present comparative statics. A small amount of LoF has no effect on low types’ behavior, but, will make high types on both sides more selective. A stronger LoF drives high types out of the market, and makes low types reverse snobs, further reducing welfare. LoF also makes rejecting strictly preferred to being rejected, making the “high types reject†equilibrium stable. We can eliminate the effects of LoF by letting the vulnerable side move second, or setting up a “Conditionally Anonymous Environment†that only reveals when both parties say yes. We motivate our model with a variety of empirical examples, and we suggest policy and managerial implications. |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:esx:essedp:14460&r=upt |
| By: | Cati Torres (Universitat de les Illes Balears); Michela Faccioli (Universitat de les Illes Balears); Antoni Riera (Universitat de les Illes Balears) |
| Abstract: | With a focus on expected climate change (CC) risks, this paper analyzes the effects of inherent uncertainty on the willingness-to-pay for a preservation policy. To do this, it relates outcome uncertainty to the probability of occurrence of an expected CC impact within a given time horizon. Thus, unlike the existing studies, this paper links outcome uncertainty to the uncontrollable component of environmental uncertainty derived from the stochastic nature of ecosystems’ behavior. Results show the support for the preservation policy is stronger in the presence of inherent uncertainty, this indicating risk aversion. In contrast, findings are not conclusive with respect to individuals’ sensitivity to the probability of impact occurrence. These results are policy relevant since they can serve to stimulate rather than discourage environmental action when it comes to contexts characterized by many uncertainties. |
| Keywords: | preference analysis, inherent uncertainty, choice experiment, adaptation, climate change. |
| JEL: | D6 D81 Q51 Q54 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:ubi:deawps:74&r=upt |
| By: | Christophette Blanchet-Scalliet (ICJ - Institut Camille Jordan [Villeurbanne] - ECL - École Centrale de Lyon - UCBL - Université Claude Bernard Lyon 1 - Université Jean Monnet - Saint-Etienne - INSA - Institut National des Sciences Appliquées - CNRS - Centre National de la Recherche Scientifique); Diana Dorobantu (ICJ - Institut Camille Jordan [Villeurbanne] - ECL - École Centrale de Lyon - UCBL - Université Claude Bernard Lyon 1 - Université Jean Monnet - Saint-Etienne - INSA - Institut National des Sciences Appliquées - CNRS - Centre National de la Recherche Scientifique); Yahia Salhi (SAF - Laboratoire de Sciences Actuarielle et Financière - UCBL - Université Claude Bernard Lyon 1) |
| Abstract: | In this paper, we study the pricing of life insurance portfolios in the presence of dependent lives. We assume that an insurer with an initial exposure to n mortality-contingent contracts wanted to acquire a second portfolio constituted of m individuals. The policyhold-ers' lifetimes in these portfolios are correlated with a Farlie-Gumbel-Morgenstern (FGM) copula, which induces a dependency between the two portfolios. In this setting, we compute the indifference price charged by the insurer endowed with an exponential utility. The optimal price is characterized as a solution to a backward differential equation (BSDE). The latter can be decomposed into (n − 1)n! auxiliary BSDEs. In this general case, the derivation of the indifference price is computationally infeasible. Therefore, while focusing on the example of death benefit contracts, we develop a model point based approach in order to ease the computation of the price. It consists on replacing each portfolio with a single policyholder that replicates some risk metrics of interest. Also, the two representative agents should adequately reproduce the observed dependency between the initial portfolios. |
| Keywords: | life insurance, utility maximization,indifference pricing, representative contract |
| Date: | 2016–01–19 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-01258645&r=upt |
| By: | Ligon, Ethan |
| Abstract: | We complete the characterization of two Frisch demand systems first developed by Browning et al (1985), and show that that these systems (i) do not restrict intertemporal substitution; but (ii) imply momentary utility functions which are additively separable in consumption. These utility functions turn out to take the well-known exponential and Stone-Geary forms. |
| Keywords: | Social and Behavioral Sciences, Frisch demands, separability, utility |
| Date: | 2016–02–04 |
| URL: | http://d.repec.org/n?u=RePEc:cdl:agrebk:qt1s06c2zp&r=upt |
| By: | Brocas, Isabelle; Carrillo, Juan D; Giga, Aleksandar; Zapatero, Fernando |
| Abstract: | We conduct a controlled laboratory experiment in which subjects dynamically choose to allocate their portfolio between (i) a safe asset, (ii) a risky asset and (iii) a skewed asset with negative expected value (a “bet”), in an environment where they can sometimes choose to acquire some information about the performance of their peers. We find three distinct groups of individuals: 16% of subjects never buy the bet, 29% of subjects learn not to buy the bet and 55% subjects persist purchasing the bet throughout the experiment. Among the latter group, purchases are most frequent when subjects are rich and when it is their last opportunity. Our subjects are also interested in the wealth of others, especially relative to theirs. Indeed, a subject with low, medium and high wealth has a preference for finding out what is the minimum, average and maximum wealth in the session, respectively. We also find that subjects buy more bets when they are richer and (unexpectedly) learn that their peers outperform them. |
| Keywords: | laboratory experiment; portfolio allocation; relative performance; skewed asset |
| JEL: | C91 D03 D81 G11 |
| Date: | 2016–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:11056&r=upt |
| By: | Hitoshi Shigeoka; Katsunori Yamada |
| Abstract: | Economists have long been aware of utility externalities such as a tendency to compare own income with others'. If welfare losses from income comparisons are significant, any governmental interventions that alter such attitudes may have large welfare consequences. We conduct an original online survey of discrete-choice questions to estimate such attitudes in the US and the UK. We find that the UK respondents compare incomes more than US respondents do. We then manipulate our respondents with simple information to examine whether the attitudes can be altered. Our information treatment suggesting that comparing income with others may diminish welfare even when income levels increase makes UK respondents compare incomes more rather than less. Interestingly, US respondents are not affected at all. The mechanism behind the UK results seems to be that our treatment gives moral license to make income comparisons by providing information that others do so. |
| Date: | 2015–03 |
| URL: | http://d.repec.org/n?u=RePEc:dpr:wpaper:0930r&r=upt |
| By: | Elisabeth Schulte (University of Marburg); Mike Felgenhauer (Plymouth University) |
| Abstract: | We study the effects of preselection on an expert’s incentive to give truthful advice in a decision environment in which certain decisions yield more precise estimates about the expert’s expertise. The introduction of a preselection stage, in which the decision maker can study the case before asking for advice, alters the expert’s perception of the problem. We identify conditions under which preselection occurs in equilibrium. We show that if the expert adjusts his behavior, the option to preselect may reduce the expected utility of the decision maker. |
| Keywords: | Reputation, cheap talk, safe haven |
| JEL: | D82 D83 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:mar:magkse:201524&r=upt |
| By: | Mauro Bambi; Alain Venditti |
| Abstract: | In this paper we study the dynamics of an economy with productive government spending under the assumption that the government balances its budget by levying endogenous non-linear consumption taxes. For standard specifcation of the utility function and production function, we prove that under counter-cyclical consumption taxes, while there exists a unique balanced growth path, sunspot equilibria based on self-fulfilling expectations occur through a form of global indeterminacy. |
| Keywords: | Endogenous growth, time-varying consumption tax, global indeterminacy, self-fulfilling expectations, sunspot equilibria. |
| JEL: | C62 E32 H20 O41 |
| Date: | 2016–01 |
| URL: | http://d.repec.org/n?u=RePEc:yor:yorken:16/01&r=upt |
| By: | Leonardo Becchetti (CEIS, University of Rome Tor Vergata); Vittorio Pelligra (University of Cagliari, CRENoS); Serena F. Taurino (University of Rome Tor Vergata) |
| Abstract: | We measure satisfaction about experimental outcomes, personal and other participants' behaviour after a multiperiod "hybrid contribution" multiplayer prisoner's dilemma called the "vote with the wallet" game. Our work shows that participants who cooperated above median (which we define as strong cooperators) are significantly more satisfied with the game in proportion to their cooperative choice. On the contrary, their satisfaction for the other players' behavior is negatively correlated with the extent of their own cooperative behavior and the non-cooperative behavior of the latter. The satisfaction of strong cooperators for their behavior in the game depends in turn on the share of their own cooperative choices. We document that a broader utility function including heterogeneity in expectations on other players' behavior, other-regarding preferences, and a negative reciprocity argument may account for the combination of the observed experimental and satisfaction findings. |
| Date: | 2016–02–01 |
| URL: | http://d.repec.org/n?u=RePEc:rtv:ceisrp:363&r=upt |
| By: | Maurice Doyon (Université Laval); Laure Saulais (Institut Paul Bocuse); Bernard Ruffieux (GAEL - Laboratoire d'Economie Appliquée de Grenoble - Institut national de la recherche agronomique (INRA) - Université Grenoble Alpes - Grenoble 2, Institut National Polytechnique de Grenoble); Denise Bweli (Egg Farmers of Canada) |
| Abstract: | Economists and market researchers often need to accurately gauge consumers’ willingness-to-pay for private goods. The experimental literature has identified a problem of hypothetical bias when using stated preferences techniques, such as open-ended questions. It has been suggested that using a cheap talk script has the potential to resolve this bias. Yet, few empirical studies on the efficiency of cheap talk for private goods exist. This study uses a between-subjects experimental design to compare consumers’ willingness-to-pay for DHA-enriched milk using three elicitation methods: 1) Hypothetical open-ended stated preference question, without monetary consequence for the respondent; 2) Idem to the first with the addition of a cheap talk script; and 3) A Vickrey auction with real monetary consequences. In this experiment subjects have the choice to participate, or not, at each period. Our results indicate a significant hypothetical bias. While the use of cheap talk has no impact on this bias, it does however increase the level of participation to the market. |
| Keywords: | experimental economics,willingness to pay,cheap talk,hypothetical bias |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-01254936&r=upt |
| By: | Nobuyuki Hanaki (GREDEG - Groupe de Recherche en Droit, Economie et Gestion - UNS - Université Nice Sophia Antipolis - CNRS - Centre National de la Recherche Scientifique); Nicolas Jacquemet (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics, CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique); Stéphane Luchini (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université Paul Cézanne - Aix-Marseille 3 - Université de la Méditerranée - Aix-Marseille 2 - EHESS - École des hautes études en sciences sociales - CNRS - Centre National de la Recherche Scientifique - AMU - Aix-Marseille Université); Adam Zylbersztejn (GATE - Groupe d'analyse et de théorie économique - UL2 - Université Lumière - Lyon 2 - Ecole Normale Supérieure Lettres et Sciences Humaines - CNRS - Centre National de la Recherche Scientifique) |
| Abstract: | How is one's cognitive ability related to the way one responds to strategic uncertainty? We address this question by conducting a set of experiments in simple 2 × 2 dominance solvable coordination games. Our experiments involve two main treatments: one in which two human subjects interact, and another in which one human subject interacts with a computer program whose behavior is known. By making the behavior of the computer perfectly predictable, the latter treatment eliminates strategic uncertainty. We find that subjects with higher cognitive ability are more sensitive to strategic uncertainty than those with lower cognitive ability. |
| Keywords: | Strategic uncertainty,Bounded rationality,Robot,Experiment |
| Date: | 2015–12 |
| URL: | http://d.repec.org/n?u=RePEc:hal:cesptp:halshs-01261036&r=upt |
| By: | Fabrizio Germano (Universitat Pompeu Fabra and Barcelona Graduate School of Economics); Peio Zuazo-Garin (Universitat Rovira i Virgili, CREIP and BRiDGE) |
| Abstract: | We study an interactive framework that explicitly allows for nonrational behavior. We do not place any restrictions on how players’ behavior deviates from rationality. Instead we assume that there exists a probability p such that all players play rationally with at least probability p, and all players believe, with at least probability p, that their opponents play rationally. This, together with the assumption of a common prior, leads to what we call the set of p-rational outcomes, which we define and characterize for arbitrary probability p. We then show that this set varies continuously in p and converges to the set of correlated equilibria as p approaches 1, thus establishing robustness of the correlated equilibrium concept to relaxing rationality and common knowledge of rationality. The p-rational outcomes are easy to compute, also for games of incomplete information, and they can be applied to observed frequencies of play to derive a measure p that bounds from below the probability with which any given player chooses actions consistent with payoff maximization and common knowledge of payoff maximization. |
| Keywords: | strategic interaction,correlated equilibrium,robustness to bounded rationality,approximate knowledge,incomplete information,measure of rationality,experiments |
| Date: | 2015–11 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:halshs-01251512&r=upt |
| By: | Majid Al-Sadoon |
| Abstract: | This paper considers linear rational expectations models from the linear systems point of view. Using a generalization of the Wiener-Hopf factorization, the linear systems approach is able to furnish very simple conditions for existence and uniqueness of both particular and generic linear rational expectations models. As applications of this approach, the paper provides results for existence of sequential solutions to block triangular systems and provides an exhaustive description of stationary and unit root solutions, including a generalization of Granger's representation theorem. In addition, the paper provides an innovative numerical solution to the Wiener-Hopf factorization and its generalization. |
| Keywords: | rational expectations, linear systems, Wiener-Hopf factorization, vector autoregressive processes, block triangular system, stability, cointegration |
| JEL: | C32 C51 C62 C63 C65 |
| Date: | 2016–01 |
| URL: | http://d.repec.org/n?u=RePEc:bge:wpaper:875&r=upt |
| By: | Muriel Fadairo (GATE Lyon Saint-Étienne - Groupe d'analyse et de théorie économique - ENS Lyon - École normale supérieure - Lyon - UL2 - Université Lumière - Lyon 2 - UCBL - Université Claude Bernard Lyon 1 - Université Jean Monnet - Saint-Etienne - PRES Université de Lyon - CNRS - Centre National de la Recherche Scientifique); Cintya Lanchimba (Escuela Politécnica Nacional, Quito, GATE Lyon Saint-Étienne - Groupe d'analyse et de théorie économique - ENS Lyon - École normale supérieure - Lyon - UL2 - Université Lumière - Lyon 2 - UCBL - Université Claude Bernard Lyon 1 - Université Jean Monnet - Saint-Etienne - PRES Université de Lyon - CNRS - Centre National de la Recherche Scientifique); Miguel Yangari (Escuela Politécnica Nacional, Quito) |
| Abstract: | Existing literature on franchising has extensively studied the presence of plural form distribution networks, where two types of vertical relationships-integration versus franchising-co-exist. However, despite the importance of monetary provisions in franchise contracts, their definition in the case of plural form networks had not been addressed. In this paper, we focus more precisely on the " share parameters " in integrated (company-owned retail outlet) and decentralized (franchised outlet) vertical contracts, respectively the commission rate and the royalty rate. We develop an agency model of payment mechanism in a two-sided moral hazard context, with one principal and two heterogenous agents distinguished by different levels of risk aversion. We define the optimal monetary provisions, and demonstrate that even in the case of segmented markets, with no correlation between demand shocks, the two rates (commission rate, royalty rate) are negatively interrelated. |
| Keywords: | moral hazard, commission rate, dual distribution, royalty rate,Franchising |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:halshs-01251344&r=upt |
| By: | Stephanie Chan (University of Amsterdam, the Netherlands); Sweder van Wijnbergen (University of Amsterdam, the Netherlands) |
| Abstract: | We highlight the ex ante risk-shifting incentives faced by a bank's shareholders/managers when CoCos (contingent convertible capital) are part of the capital structure. The risk shifting incentive arises from the wealth transfers that the shareholders will receive upon the CoCo's conversion under CoCo designs widely used in practice. Specifically we show that for principal writedown and nondilutive equity-converting CoCos, shareholders/managers have an incentive to take on more risk to make conversion more likely because of those wealth transfers. As a consequence, wide spread use of CoCos will increase systemic fragility. We show that such improperly designed CoCos should not be allowed to fill in loss absorption capacity requirements unless accompanied by higher required equity ratios to mitigate the increased risk taking incentives they lead to. Sufficiently dilutive CoCos do not lead to undesired risk taking behavior. |
| Keywords: | Contingent Convertible Capital, Systemic Risk, Risk Shifting Incentives, Capital Requirements |
| JEL: | G01 G13 G21 G28 G32 |
| Date: | 2016–02–01 |
| URL: | http://d.repec.org/n?u=RePEc:tin:wpaper:20160007&r=upt |
| By: | Fagereng, Andreas; Guiso, Luigi; Pistaferri, Luigi |
| Abstract: | Estimating the effect of background risk on individual financial choices faces two challenges. First, the identification of the marginal effect requires a measure of at least one component of human capital risk that qualifies as "background" (a risk that an individual cannot diversify or avoid). Absent this, estimates suffer from measurement error and omitted variable bias. Moreover, measures of background risk must vary over time to eliminate unobserved heterogeneity. Second, once the marginal effect is identified, an evaluation of the economic significance of background risk requires knowledge of the size of all the background risk actually faced. Existing estimates are problematic because measures of background risk fail to satisfy the "non-avoidability" requirement. This creates a downward bias which is at the root of the small estimated effect of background risk. To tackle the identification problem we match panel data of workers and firms and use the variability in the profitability of the firm that is passed over to workers to obtain a measure of risk that is hardly avoidable. We rely on this measure to instrument total variability in individual earnings and find that the marginal effect of background risk is much larger than estimates that ignore endogeneity. We bound the economic impact of human capital background risk and find that its overall effect is contained, not because its marginal effect is small but because its size is small. And size of background risk is small because firms provide substantial wage insurance. |
| Keywords: | background risk; portfolio choice; uninsurable labor income risk |
| JEL: | E20 E24 G11 |
| Date: | 2016–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:11051&r=upt |