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Consumption and Savings with Unemployment Risk: Implications for Optimal Employment Contracts

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  • Christopher A. Pissarides

Abstract

This paper derives optimal employment contracts when workers are risk averse and there are employment and unemployment risks. Without income insurance, consumption rises during employment and falls during unemployment. Optimal employment contracts offer severance compensation to smooth consumption during employment without causing moral hazard. A pre-announced delay in dismissal when the job becomes unproductive provides further insurance but because of moral hazard it does not fully smooth consumption. During the delay consumption falls and the worker searches for another job. No delays in dismissals are optimal if exogenous unemployment compensation is sufficiently generous.

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Bibliographic Info

Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp0542.

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Date of creation: Aug 2002
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Handle: RePEc:cep:cepdps:dp0542

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Web page: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEP

Related research

Keywords: employment risk; unemployment risk; severance compensation; notice of dismissal;

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References

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  1. Ljungqvist, Lars & Sargent, Thomas J., 1997. "The European Unemployment Dilemma," Working Paper Series in Economics and Finance 178, Stockholm School of Economics.
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Citations

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Cited by:
  1. Giulio Fella, 2007. "Optimal Severance Pay in a Matching Model," Working Papers 598, Queen Mary, University of London, School of Economics and Finance.
  2. Blanchard, Olivier & Tirole, Jean, 2006. "The Joint Design of Unemployment Insurance and Employment Protection: A First Pass," IDEI Working Papers 258, Institut d'Économie Industrielle (IDEI), Toulouse.
  3. Andersson, Linda, 2008. "Net Taxes,Income Stabilization and Regional Job Flows in Sweden," Working Papers 2008:5, Örebro University, School of Business.
  4. Guler, Bulent & Guvenen, Fatih & Violante, Giovanni L., 2012. "Joint-search theory: New opportunities and new frictions," Journal of Monetary Economics, Elsevier, vol. 59(4), pages 352-369.
  5. Olivier Blanchard & Jean Tirole, 2004. "The Optimal Design of Unemployment Insurance and Employment Protection. A First Pass," NBER Working Papers 10443, National Bureau of Economic Research, Inc.

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