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Under-Insurance in Human Capital Models with Limited Enforcement

Listed author(s):
  • Tom Krebs

    (University of Mannheim)

  • Moritz Kuhn

    (University of Bonn)

  • Mark Wright

    (Federal Reserve Bank of Chicago)

This paper uses a macroeconomic model calibrated to U.S data to show that limited contract enforcement leads to substantial under-insurance against human capital risk. The model economy is populated by a large number of risk-averse households who can invest in risk-free physical capital and risky human capital. Expected human capital returns are age-dependent and calibrated to match the observed life-cycle profile of median labor income. Households have access to a complete set of credit and insurance contracts, but their ability to use the available financial instruments is limited by the possibility of default (limited contract enforcement). According to the baseline calibration, young households are severely under-insured against human capital (labor income) risk and the welfare losses due to the lack of insurance are substantial. These results are robust to realistic variations in parameter values. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/j.red.2017.02.008
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Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 25 (2017)
Issue (Month): (April)
Pages: 121-150

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Handle: RePEc:red:issued:16-122
DOI: 10.1016/j.red.2017.02.008
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  1. Tom Krebs & Moritz Kuhn & Mark L. J. Wright, 2015. "Human Capital Risk, Contract Enforcement, and the Macroeconomy," American Economic Review, American Economic Association, vol. 105(11), pages 3223-3272, November.
  2. Krueger, Dirk & Uhlig, Harald, 2006. "Competitive risk sharing contracts with one-sided commitment," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1661-1691, October.
  3. Benjamin Moll, 2014. "Productivity Losses from Financial Frictions: Can Self-Financing Undo Capital Misallocation?," American Economic Review, American Economic Association, vol. 104(10), pages 3186-3221, October.
  4. Alexis Akira Toda, 2015. "Asset Prices and Efficiency in a Krebs Economy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(4), pages 957-978, October.
  5. Timothy J. Kehoe & David K. Levine, 1993. "Debt-Constrained Asset Markets," Review of Economic Studies, Oxford University Press, vol. 60(4), pages 865-888.
  6. Peter A. Streufert, 1990. "Stationary Recursive Utility and Dynamic Programming under the Assumption of Biconvergence," Review of Economic Studies, Oxford University Press, vol. 57(1), pages 79-97.
  7. Greg Kaplan & Giovanni L. Violante, 2010. "How Much Consumption Insurance beyond Self-Insurance?," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(4), pages 53-87, October.
  8. Jones, Larry E & Manuelli, Rodolfo E, 1990. "A Convex Model of Equilibrium Growth: Theory and Policy Implications," Journal of Political Economy, University of Chicago Press, vol. 98(5), pages 1008-1038, October.
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