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The Choice of Institutions: The Role of Risk and Risk-Aversion

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Author Info
Diana Weinhold (London School of Economics)
Paul J. Zak (Claremont Graduate University)

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Abstract

Institutions can affect individual behavior both via their efficiency impact and via their risk reducing mechanisms. However there has been little study of the relative importance of these two channels in how individuals choose between simultaneously extant institutions. This paper presents a simple model of institutional choice in a labor market when there is a risk/reward trade-off, and tests the predictions of the theory. Using a novel empirical approach that adapts an ARCH-in-mean to cross-sectional survey data from China, we find that risk and risk aversion are strongly related to the choice of a labor market institution. Further, risk and risk aversion are quantitatively more important than the sectoral wage differential in explaining employment institution choices. Specifically, we find that wage risk has two orders of magnitude greater impact on labor market institutional choice than the wage difference, with a one standard deviation increase in earnings risk reducing the number of workers choosing jobs in the private (risky) sector by 22%.

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Paper provided by EconWPA in its series Others with number 0508004.

Download reference. The following formats are available: HTML, plain text, BibTeX, RIS (EndNote), ReDIF
Length: 22 pages
Date of creation: 06 Aug 2005
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Handle: RePEc:wpa:wuwpot:0508004

Note: Type of Document - pdf; pages: 22
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Web page: http://129.3.20.41

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Related research
Keywords: Institutions Risk Labor Market Risk Aversion

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Find related papers by JEL classification:
P3 - Economic Systems - - Socialist Institutions and Their Transitions
J21 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Labor Force and Employment, Size, and Structure
J40 - Labor and Demographic Economics - - Particular Labor Markets - - - General

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  1. Cheung, Steven N S, 1969. "Transaction Costs, Risk Aversion, and the Choice of Contractual Arrangements," Journal of Law & Economics, University of Chicago Press, vol. 12(1), pages 23-42, April.
  2. Hamermesh, Daniel S & Biddle, Jeff E, 1994. "Beauty and the Labor Market," American Economic Review, American Economic Association, vol. 84(5), pages 1174-94, December. [Downloadable!] (restricted)
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  3. Parsons, Donald O., 1987. "The employment relationship: Job attachment, work effort, and the nature of contracts," Handbook of Labor Economics, in: O. Ashenfelter & R. Layard (ed.), Handbook of Labor Economics, edition 1, volume 2, chapter 14, pages 789-848 Elsevier. [Downloadable!] (restricted)
  4. Daron Acemoglu & Simon Johnson & James A. Robinson, 2001. "The Colonial Origins of Comparative Development: An Empirical Investigation," American Economic Review, American Economic Association, vol. 91(5), pages 1369-1401, December. [Downloadable!] (restricted)
    Other versions:
  5. Hayashi, Fumio & Altonji, Joseph & Kotlikoff, Laurence, 1996. "Risk-Sharing between and within Families," Econometrica, Econometric Society, vol. 64(2), pages 261-94, March. [Downloadable!] (restricted)
  6. Shaw, Kathryn L, 1996. "An Empirical Analysis of Risk Aversion and Income Growth," Journal of Labor Economics, University of Chicago Press, vol. 14(4), pages 626-53, October. [Downloadable!] (restricted)
  7. Chetan Ghate & Quan Vu Le & Paul J. Zak, 2003. "Optimal Fiscal Policy in an Economy Facing Sociopolitical Instability," Review of Development Economics, Blackwell Publishing, vol. 7(4), pages 583-598, November. [Downloadable!] (restricted)
  8. Weiss, Yoram, 1972. "The Risk Element in Occupational and Educational Choices," Journal of Political Economy, University of Chicago Press, vol. 80(6), pages 1203-13, Nov.-Dec.. [Downloadable!] (restricted)
  9. Levhari, David & Weiss, Yoram, 1974. "The Effect of Risk on the Investment in Human Capital," American Economic Review, American Economic Association, vol. 64(6), pages 950-63, December. [Downloadable!] (restricted)
  10. Brixiova, Zuzana & Kiyotaki, Nobuhiro, 1997. "Private sector development in transition economies," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 46(1), pages 241-279, June. [Downloadable!] (restricted)
  11. Barbara Petrongolo & Christopher A. Pissarides, 2001. "Looking into the Black Box: A Survey of the Matching Function," Journal of Economic Literature, American Economic Association, vol. 39(2), pages 390-431, June. [Downloadable!] (restricted)
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  12. Ormiston, Michael B & Schlee, Edward E, 1994. "Wage Uncertainty and Competitive Equilibrium in Labour Markets," Economica, London School of Economics and Political Science, vol. 61(242), pages 137-45, May. [Downloadable!] (restricted)
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