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Insurance in human capital models with limited enforcement

Author

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  • Tom Krebs
  • Moritz Kuhn
  • Mark Wright

Abstract

This paper develops a tractable human capital model with limited enforceability of contracts. The model economy is populated by a large number of long-lived, risk-averse households with homothetic preferences who can invest in risk-free physical capital and risky human capital. 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). We provide a convenient equilibrium characterization that facilitates the computation of recursive equilibria substantially. We use a calibrated version of the model with stochastically aging households divided into 9 age groups. Younger households have higher expected human capital returns than older households. According to the baseline calibration, for young households less than half of human capital risk is insured and the welfare losses due to the lack of insurance range from 3 percent of lifetime consumption (age 40) to 7 percent of lifetime consumption (age 23). Realistic variations in the model parameters have non-negligible effects on equilibrium insurance and welfare, but the result that young households are severely underinsured is robust to such variations.

Suggested Citation

  • Tom Krebs & Moritz Kuhn & Mark Wright, 2016. "Insurance in human capital models with limited enforcement," CAMA Working Papers 2016-48, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  • Handle: RePEc:een:camaaa:2016-48
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    File URL: https://cama.crawford.anu.edu.au/sites/default/files/publication/cama_crawford_anu_edu_au/2016-08/48_2016krebs_kuhn_wright.pdf
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    References listed on IDEAS

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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. Ethan Ligon & Jonathan P. Thomas & Tim Worrall, 2002. "Informal Insurance Arrangements with Limited Commitment: Theory and Evidence from Village Economies," Review of Economic Studies, Oxford University Press, vol. 69(1), pages 209-244.
    3. Richard Blundell & Lorraine Dearden & Costas Meghir & Barbara Sianesi, 1999. "Human capital investment: the returns from education and training to the individual, the firm and the economy," Fiscal Studies, Institute for Fiscal Studies, vol. 20(1), pages 1-23, March.
    4. 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.
    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. Jonathan Heathcote & Fabrizio Perri & Giovanni L. Violante, 2010. "Unequal We Stand: An Empirical Analysis of Economic Inequality in the United States: 1967-2006," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 13(1), pages 15-51, January.
    7. 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.
    8. Dirk Krueger & Fabrizio Perri, 2006. "Does Income Inequality Lead to Consumption Inequality? Evidence and Theory -super-1," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 163-193.
    9. 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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    1. repec:red:ecodyn:v:18:y:2017:i:1:agenda is not listed on IDEAS

    More about this item

    Keywords

    Human Capital Risk; Limited Enforcement; Insurance;

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • J24 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Human Capital; Skills; Occupational Choice; Labor Productivity

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