DP3367 Consumption and Savings with Unemployment Risk: Implications for Employment Contracts
|Publication Date:||May 2002|
|Keyword(s):||employment risk, notice of dismissal, severence compensation, unemployment risk|
|JEL(s):||E21, E24, J32, J33|
|Programme Areas:||International Macroeconomics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=3367|
This Paper derives optimal employment contracts when workers are risk-averse and there are employment and unemployment risks. Without income insurance, consumption rises during employment and falls during unemployment. Optimal employment contracts offer severance compensation to smooth consumption during employment without causing moral hazard. A pre-announced delay in dismissal when the job becomes unproductive provides further insurance but because of moral hazard it does not fully smooth consumption. During the delay consumption falls and the worker searches for another job. No delays in dismissals are optimal if exogenous unemployment compensation is sufficiently generous.