Working Paper: NBER ID: w22883
Authors: Andreas Fagereng; Luigi Guiso; Luigi Pistaferri
Abstract: Assessing the importance of uninsurable wage risk for individual financial choices faces two challenges. First, the identification of the marginal effect requires a measure of at least one component of risk that cannot be diversified or avoided. Moreover, measures of uninsurable wage risk must vary over time to eliminate unobserved heterogeneity. Second, evaluating the economic significance of risk requires knowledge of the size of all the wage risk actually faced. Existing estimates are problematic because measures of wage risk fail to satisfy the ”non-avoidability” requirement. This creates a downward bias which is at the root of the small estimated effect of wage risk on portfolio choices. To tackle this 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 uninsurable risk. Using this measure to instrument total variability in individual earnings, we find that the marginal effect of uninsurable wage risk is much larger than estimates that ignore endogeneity. We bound the economic impact of risk and find that its overall effect is contained, not because its marginal effect is small but because its size is small. And the size of uninsurable wage risk is small because firms provide substantial wage insurance.
Keywords: uninsurable wage risk; portfolio choice; firm shocks; financial decisions
JEL Codes: D14; D91; G11; J3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| uninsurable wage risk (J32) | portfolio choices (G11) |
| wage variability (endogeneity not accounted for) (J31) | marginal effect of uninsurable wage risk on portfolio allocation (G52) |
| wage variability (instrumented with firm-variation) (J31) | marginal effect of uninsurable wage risk on portfolio allocation (G52) |
| uninsurable wage risk (J32) | portfolio allocation (varies across individuals) (G11) |
| uninsurable wage risk (J32) | portfolio allocation (diminishes to zero for high-wealth individuals) (G11) |
| wage insurance provided by firms (J38) | size of uninsurable wage risk (G52) |