Uninsurable Individual Risk And The Cyclical Behavior Of Unemployment And Vacancies

This paper is concerned with the business cycle dynamics in search-and-matching models of the labor market when agents are ex post heterogeneous. The authors focus on wealth heterogeneity that comes as a result of imperfect opportunities to insure against idiosyncratic risk. They show that this heterogeneity implies wage rigidity relative to a complete insurance economy. The fraction of wealth-poor agents prevents real wages from falling too much in recessions since small decreases in income imply large losses in utility. Analogously, wages raise less in expansions compared with the standard model because small increases are enough for poor workers to accept job offers. This mechanism reduces the volatility of wages and increases the volatility of vacancies and unemployment.