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Idiosyncratic Risk and Aggregate Employment Dynamics

  • Jeffrey R. Campbell
  • Jonas D.M.Fisher

This paper studies how producers' idiosyncratic risks affect an industry's aggregate dynamics in an environment where certainty equivalence fails. In the model, producers can place workers in two types of jobs, organized and temporary. Workers are less productive in temporary jobs, but creating an organized job requires an irreversible investment of managerial resources. Increasing productivity risk raises the value of an unexercised option to create an organized job. Losing this option is one cost of immediate organized job creation, so an increase in its value induces substitution towards cheaper temporary jobs. Because they are costless to create and destroy, a producer using temporary jobs can be more flexible, responding more to both idiosyncratic and aggregate shocks. If all of an industry's producers adapt to heightened idiosyncratic risk in this way, the industry as a whole can respond more to a given aggregate shock. This insight is used to better understand the observation from the U.S. manufacturing sector that groups of plants displaying high idiosyncratic variability also have large aggregate fluctuations.

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File URL: http://www.nber.org/papers/w7936.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7936.

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Date of creation: Oct 2000
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Publication status: published as Campbell, Jeffrey R. and Jonas D. M. Fisher. "Idiosyncratic Risk And Aggregate Employment Dynamics," Review of Economic Dynamics, 2004, v7(2,Apr), 331-353.
Handle: RePEc:nbr:nberwo:7936
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