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Risk Sharing through Labor Contracts - Risk Aversion, Market Incompleteness and Employment

  • Sunanda Roy

    (University of Southern California)

Labor contracts are a way of sharing idiosyncratic production risks between entrepreneurs and workers, especially when such risks are too complex for contingent contracts to be written on them. So it is important to understand how equilibrium employment and wages are affected by risk re-lated factors, such as risk aversion of entrepreneurs and workers, risk sharing opportunities in the economy etc. The paper develops a general equilibrium model with several sectors of production which are subject to idiosyncratic productivity shocks, two inputs - labor and capital - and stock markets which diversify sectoral risks but not completely. We prove the existence of equilibrium for this general model. The model is then parameterized by CRRAutility functions. We prove that the equilibriumemployment levels vary inversely with the coefficient of relative risk aversion of agents under certain conditions. Numerical simulations show that over a range of the coefficient employment levels are higher when markets are complete than when they are not. A substantive implication of the comparative static results is that a low paying, productively less efficient alter-native to working for private firms may be desirable as an insurance instrument.

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Paper provided by Econometric Society in its series Econometric Society World Congress 2000 Contributed Papers with number 1767.

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Date of creation: 01 Aug 2000
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Handle: RePEc:ecm:wc2000:1767
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  1. Martine Quinzii & Michael Magill, 2003. "Incentives and Risk Sharing in a Stock Market Equilibrium," Working Papers 9612, University of California, Davis, Department of Economics.
  2. Azariadis, Costas, 1975. "Implicit Contracts and Underemployment Equilibria," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1183-1202, December.
  3. Arnott, Richard & Stiglitz, Joseph E, 1991. "Moral Hazard and Nonmarket Institutions: Dysfunctional Crowding Out or Peer Monitoring?," American Economic Review, American Economic Association, vol. 81(1), pages 179-90, March.
  4. Atkeson, Andrew & Kehoe, Patrick J, 1996. "Social Insurance and Transition," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 37(2), pages 377-401, May.
  5. Milgrom, Paul & Shannon, Chris, 1994. "Monotone Comparative Statics," Econometrica, Econometric Society, vol. 62(1), pages 157-80, January.
  6. Mathias Dewatripont, 1992. "Economic Reform and Dynamic Political Constraints," ULB Institutional Repository 2013/175991, ULB -- Universite Libre de Bruxelles.
  7. Villas-Boas, J. Miguel, 1997. "Comparative Statics of Fixed Points," Journal of Economic Theory, Elsevier, vol. 73(1), pages 183-198, March.
  8. Paul Gomme & Jeremy Greenwood, 1992. "On the cyclical allocation of risk," Discussion Paper / Institute for Empirical Macroeconomics 71, Federal Reserve Bank of Minneapolis.
  9. Michele Boldrin & Michael Horvath, 1994. "Labor Contracts and Business Cycles," Discussion Papers 1068, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  10. Fernandez, Raquel & Rodrik, Dani, 1991. "Resistance to Reform: Status Quo Bias in the Presence of Individual-Specific Uncertainty," American Economic Review, American Economic Association, vol. 81(5), pages 1146-55, December.
  11. Cheng, Hsueh-Cheng & Magill, Michael J P & Shafer, Wayne J, 1987. "Some Results on Comparative Statics under Uncertainty," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 28(2), pages 493-507, June.
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