Date Added: Aug 2009
The authors analyze a Bewley-Huggett-Aiyagari incomplete-markets model with labor-market frictions. Consumers are subject to idiosyncratic employment shocks against which they cannot insure directly. The labor market has a Diamond-Mortensen-Pissarides structure: firms enter by posting vacancies and match with workers bilaterally, with match probabilities given by an aggregate matching function. Wages are determined through Nash bargaining. They also consider aggregate productivity shocks and a complete set of contingent claims conditional on this risk. They use the model to evaluate a tax-financed unemployment insurance scheme. Higher insurance is beneficial for consumption smoothing, but because it raises workers' outside option value, it discourages firm entry.