Working Paper: CEPR ID: DP16444
Authors: Almut Balleer; Georg Duerncker; Susanne Forstner; Johannes Goensch
Abstract: Idiosyncratic labor risk is a prevalent phenomenon with important implications for individual choices. In labor market research it is commonly assumed that agents have rational expectations and therefore they correctly assess the risk they face in the labor market. We analyze survey data for the U.S. and document a substantial optimistic bias of households in their subjective expectations about future labor market transitions. Furthermore, we analyze the heterogeneity in the bias across different demographic groups and we find that high-school graduates tend to be vastly over-optimistic about their labor market prospects, whereas college graduates have rather precise beliefs. In the context of a quantitative heterogenous agents lifecycle model we show that the optimistic bias has a quantitatively sizable negative effect on the life-cycle allocation of income, consumption and wealth and implies a substantial loss in individual welfare compared to the allocation under full information. Moreover, we establish that the heterogeneity in the bias leads to pronounced differences in the accumulation of assets across individuals, and is thereby a quantitatively important driver of inequality in wealth.
Keywords: subjective expectations; labor markets; consumption; saving; wealth inequality
JEL Codes: E21; D84
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| optimistic biases in labor market expectations (J29) | overestimate probability of favorable labor market transitions (J49) |
| optimistic biases in labor market expectations (J29) | underestimate likelihood of negative transitions (D81) |
| overestimate probability of favorable labor market transitions (J49) | lower savings rates (D14) |
| overestimate probability of favorable labor market transitions (J49) | reduced asset accumulation (D14) |
| underestimate likelihood of negative transitions (D81) | lower savings rates (D14) |
| underestimate likelihood of negative transitions (D81) | reduced asset accumulation (D14) |
| optimistic biases in labor market expectations (J29) | lower level of lifetime utility (D11) |
| optimistic biases in labor market expectations (J29) | increase in wealth Gini coefficient (D31) |
| biased expectations (D91) | distort intertemporal consumption decisions (D15) |
| distort intertemporal consumption decisions (D15) | lower savings and asset holdings (D14) |