Unemployment insurance and uncertainty: Theoretical modelling of risks and incentives

This article develops a theoretical model of unemployment insurance under uncertainty, combining risk and insurance theory (Knight, 1921; Allais, 1953; Borch, 1968, 1990) with growth and automation models (Zeira, 1998; Aghion et al., 2017). The model analyses both direct and indirect effects of unemployment insurance on unemployment duration and labour market equilibrium. The direct channel increases the reservation wage, reducing individual uncertainty but potentially prolonging unemployment. The indirect channel reflects distortions in hiring incentives and firm financing, which may either raise structural unemployment or improve job–worker matching depending on productivity distribution. The originality of the framework lies in formalising the balance between these two channels through the condition E_D??E_IND?. This extends existing models (Albrecht and Axell, 1984; Eckstein and Wolpin, 1990; Schmieder and Von Wachter, 2016) by embedding micro level analyses into a broader equilibrium structure. The results highlight that the optimal design of unemployment insurance must balance protection and incentives, adapt benefits to heterogeneous preferences, and account for labour market structures. This is particularly important in developing economies where stabilisation and inclusiveness are essential.