Conferences at Department of Economics, University of Toronto, RCEF 2012: Cities, Open Economies, and Public Policy

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Household Risk and Insurance over the Life Cycle

Andres Erosa, Luisa Fuster, Gueorgui Kambourov*

Last modified: 2012-08-02


The household, as an entity, is important for understanding the individual and aggregate labor supply
responses to changes in the economic environment. Explicitly modelling the household could, for
example, provide insights into the various risks which individuals face, the way household members
react to and insure against these risks through changes in their labor supply behavior, and the effects
of various government policies and aggregate business cycle shocks. We begin the analysis by
estimating, on U.S. data from 1984 till 2010, a quarterly household wage process in which we allow for
correlation between the shocks of husbands and wives and explicitly correct for selection bias in male
and female labor market participation. In addition, we estimate the household wage process for four
separate household groups - depending on the spouses' education levels. We proceed by building a
life-cycle model of the household which features a quarterly model period, four distinct household groups,
an intensive and extensive labor supply margin, labor market risk and incomplete markets, correlated
wage shocks between husbands and wives, and unemployment shocks and labor market frictions. The
model is calibrated to U.S. data from the Survey of Income and Program Participation (SIPP) and the
Panel Study of Income Dynamics (PSID). First, we use the model to analyze the individual and aggregate
labor supply response to a temporary or permanent aggregate productivity shock. Second, we study the
effects of various government policies, such as unemployment insurance and social assistance programs.
Finally, in order to capture the recent severe recession in the United States, we simulate a negative
aggregate productivity shock which lasts for at least six years and study the various mechanisms through
which household labor supply reacts to such a change in the economic environment.


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