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The Choice of Institutions: The Role of Risk and Risk-Aversion

Author

Listed:
  • Diana Weinhold

    (London School of Economics)

  • Paul J. Zak

    (Claremont Graduate University)

Abstract

Institutions can affect individual behavior both via their efficiency impact and via their risk reducing mechanisms. However there has been little study of the relative importance of these two channels in how individuals choose between simultaneously extant institutions. This paper presents a simple model of institutional choice in a labor market when there is a risk/reward trade-off, and tests the predictions of the theory. Using a novel empirical approach that adapts an ARCH-in-mean to cross-sectional survey data from China, we find that risk and risk aversion are strongly related to the choice of a labor market institution. Further, risk and risk aversion are quantitatively more important than the sectoral wage differential in explaining employment institution choices. Specifically, we find that wage risk has two orders of magnitude greater impact on labor market institutional choice than the wage difference, with a one standard deviation increase in earnings risk reducing the number of workers choosing jobs in the private (risky) sector by 22%.

Suggested Citation

  • Diana Weinhold & Paul J. Zak, 2005. "The Choice of Institutions: The Role of Risk and Risk-Aversion," Others 0508004, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpot:0508004
    Note: Type of Document - pdf; pages: 22
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    References listed on IDEAS

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    Cited by:

    1. Michalis Drouvelis & Julian C. Jamison, 2015. "Selecting public goods institutions: Who likes to punish and reward?," Southern Economic Journal, Southern Economic Association, vol. 82(2), pages 501-534, October.
    2. Michalis Drouvelis & Julian C. Jamison, 2015. "Selecting public goods institutions: Who likes to punish and reward?," Southern Economic Journal, John Wiley & Sons, vol. 82(2), pages 501-534, October.

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    JEL classification:

    • P3 - Political Economy and Comparative Economic Systems - - Socialist Institutions and Their Transitions
    • J21 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Labor Force and Employment, Size, and Structure
    • J40 - Labor and Demographic Economics - - Particular Labor Markets - - - General

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