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A Life-Cycle Model with Unemployment Traps

Author

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  • Fabio C. Bagliano

    (Department of Economics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino, Italy)

  • Carolina Fugazza

    (Department of Economics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino, Italy)

  • Giovanna Nicodano

    (Department of Economics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino, Italy)

Abstract

The Great Recession has highlighted that long-term unemployment may become a trap with loss of human capital. This paper extends the life-cycle model allowing for a small risk of long-term unemployment with permanent effects on labour income. Such nonlinear income risk dampens both early consumption and early investment in risky assets, resulting in an optimal equity portfolio share relatively flat in age. The driver of such flattening in the life-cycle profile is the resolution of uncertainty, as the worker ages, concerning this personal disaster. Shifting to such flatter investment profile away from a simple "age rule" delivers mean welfare gains that are three times larger than in models with linear labour income shocks.

Suggested Citation

  • Fabio C. Bagliano & Carolina Fugazza & Giovanna Nicodano, 2017. "A Life-Cycle Model with Unemployment Traps," Working papers 041, Department of Economics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino.
  • Handle: RePEc:tur:wpapnw:041
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    References listed on IDEAS

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    Cited by:

    1. Gomes, Francisco J & Haliassos, Michael & Ramadorai, Tarun, 2020. "Household Finance," CEPR Discussion Papers 14502, C.E.P.R. Discussion Papers.

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    More about this item

    Keywords

    Disaster risk; Life-cycle portfolio choice; Unemployment risk; Human capital depreciation; Age rule.;
    All these keywords.

    JEL classification:

    • D15 - Microeconomics - - Household Behavior - - - Intertemporal Household Choice; Life Cycle Models and Saving
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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