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A real options analysis of dual labor markets and the single labor contract


  • Gete, Pedro
  • Porchia, Paolo


We study the optimal hiring and firing decisions of a firm under two different firing costs regulations: 1) Dual labor markets characterized by high firing costs for workers with seniority above a threshold ("permanent workers") and by low costs for "temporary workers". 2) The Single Labor Contract, a policy proposal to make firing costs increasing in seniority at the job. We focus on the option value implied by the regulations and obtain some new results: the optimal firing rule is a constant function of worker's productivity only for permanent workers. For temporary workers it varies with seniority at the job because the firm tries to keep alive the option to fire at low cost. In the Dual regulation the workers more likely to be fired are those close to become permanent. On the contrary, the Single Contract transfers that maximum firing to the new hires. Thus, fired workers are fired sooner under the Single Contract. However, if both regulations have the same average firing cost for workers who become permanent, temporary workers are less likely to be fired in the Single Contract. Moreover, this new regulation increases hiring and average employment duration. It also reduces turnover among temporary workers, but at the expense of higher turnover among permanent workers who are more often replaced by temporary workers.

Suggested Citation

  • Gete, Pedro & Porchia, Paolo, 2011. "A real options analysis of dual labor markets and the single labor contract," MPRA Paper 34055, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:34055

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    References listed on IDEAS

    1. Samuel Bentolila & Juan J. Dolado & Pierre Cahuc & Thomas Le Barbanchon, 2010. "Two-Tier Labor Markets in the Great Recession: France Vs. Spain," Working Papers wp2010_1009, CEMFI.
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    More about this item


    Real Options; Dual Labor; Single Contract;

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • J40 - Labor and Demographic Economics - - Particular Labor Markets - - - General
    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • D20 - Microeconomics - - Production and Organizations - - - General
    • J01 - Labor and Demographic Economics - - General - - - Labor Economics: General
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • A10 - General Economics and Teaching - - General Economics - - - General

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