Working Paper: NBER ID: w25764
Authors: Eric T. Swanson
Abstract: A flexible labor margin allows households to absorb shocks to asset values with changes in hours worked as well as changes in consumption. This ability to partially offset wealth shocks by varying hours of work can significantly alter the household’s attitudes toward risk, as shown in Swanson (2012). In this paper, I analyze how frictional labor markets affect that analysis. Household risk aversion (as measured by willingness to pay to avoid a wealth shock) is higher: 1) in countries with more frictional labor markets, 2) in recessions, and 3) for households that have more difficulty finding a job. These predictions are consistent with empirical evidence from a variety of sources. Quantitatively, I show that labor market frictions in Europe are large enough to play a substantial contributing role to risk aversion in those countries. Nevertheless, labor markets in the U.S. and Europe are sufficiently flexible that risk aversion is much closer to the frictionless benchmark in Swanson (2012) than to traditional measures that assume labor is fixed.
Keywords: Risk Aversion; Labor Market Frictions; Risk Premia
JEL Codes: D81; E24; E44; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| labor market frictions (J29) | household risk aversion (D11) |
| frictional labor markets (J69) | household risk aversion (D11) |
| ability to adjust labor supply (J29) | household risk aversion (D11) |
| recessions (E32) | household risk aversion (D11) |
| unemployment rises (J64) | household risk aversion (D11) |
| difficulty in employment adjustment (J68) | household risk aversion (D11) |
| less likely to find jobs (J79) | household risk aversion (D11) |