Ruhr Economic Papers

Ruhr Economic Papers #771

Hours Risk, Wage Risk, and Life-Cycle Labor Supply

by Robin Jessen and Johannes König

RWI, 10/2018, 30 S./p., 8 Euro, ISBN 978-3-86788-899-8 DOI: 10.4419/86788899

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Abstract

We decompose permanent earnings risk into contributions from hours and wage
shocks. In order to distinguish between hours shocks and labor supply reactions to
wage shocks we use a life-cycle model of consumption and labor supply. Estimating
our model with the Panel Study of Income Dynamics (PSID) shows that both permanent
wage and hours shocks play an important role in explaining the cross-sectional variance
in earnings growth, but wage risk has greater relevance. Allowing for hours shocks
improves the model fit considerably. The empirical strategy allows for the estimation of
the Marshallian labor supply elasticity without the use of consumption or asset data.
We find this elasticity on average to be negative, but small. The degree of consumption
insurance implied by our results is in line with recent estimates in the literature.

JEL-Classification: D31, J22, J31

Keywords: Earnings risk; wage risk; Frisch elasticity; Marshallian elasticity; consumption insurance

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