The Effects of Individual Misperceptions of Labor Market Risk on Macroeconomic Outcomes

Abstract

Labor market risk is a prevalent phenomenon that shapes the behavior of individuals with respect to a number of choices, including wage bargaining, consumption-savings allocations, job search, portfolio composition or human capital accumulation. Through its effect on individual behavior, labor market risk also has important consequences for aggregate outcomes such as employment, physical capital accumulation, wage growth and business cycles. In the literature, it is common to assume agents have rational expectations and correctly assess the risk they face in the labor market. In this project, we first investigate how accurately individuals can assess their own labor market risk in a detailed empirical analysis. Preliminary data exploration indicates that the degree of misperception is significant. We then analyze the implications of such misperception for individual as well as macroeconomic outcomes. We do so within the framework of a quantitative macroeconomic model featuring incomplete markets, search-and-matching, and individual misperception of labor market risk.

Related